Commodities

Global
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Global Research

Precious Metals  For gold, unease about monetary and

fiscal policies should rekindle the rally;
Outlook supply is likely to rise modestly

Bound to rebound; raising our price  For silver, strong industrial demand and
forecasts a recovery in investor appetite should
offset mine and scrap supply growth

 Industrial demand is boosting PGM off-

take; ETFs hold sizeable metal; eroding
Russian stocks may buoy palladium

We are raising our average price forecasts for gold, silver,

and the platinum group metals and introducing forecasts
for 2013 (see the table below). The bull markets remain
essentially intact for gold and the PGMs, and although silver is
priced closer to its equilibrium value, its near-term bias is
upward, in our view.

Gold: Prices have retreated from record highs. But they should
remain buoyed by investor concerns about the global economy,
geopolitical risks, high commodity prices, easy monetary
policies, and fiscal profligacy. Increased mine output, ample
scrap supplies, and moderate jewelry demand are freeing up
metal for the investment sector.

Silver: Prices have corrected sharply from 31-year highs near

10 May 2011
USD50/oz. Higher mine and scrap supplies are being absorbed
James Steel
by robust industrial off-take. Investors have favored silver and
Analyst
HSBC Securities (USA) Inc. coin sales, but prices appear high, especially relative to gold.
+1 212 525 6515 james.steel@us.hsbc.com
PGMs: Moderating growth in auto demand and robust
industrial off-take are offsetting slow growth in mine supply.
Platinum jewelry demand is moderating. PGM ETFs hold
considerable amounts of metal. Widespread belief that Russian
stockpiles are near exhaustion supports palladium prices.

HSBC precious metals average price forecasts (USD/oz)

___2011 ____ ___ 2012 ____ ___2013 ____ _ Long term __
Old New Old New Old New Old New
Gold 1,450 1,525 1,300 1,500 — 1,450 1,050 1,250
View HSBC Global Research at: http://www.research.hsbc.com Silver 26 34 20 29 — 24 15 20
Platinum 1,750 1,850 1,650 1,750 — 1,650 1,600 1,625
Palladium 750 825 650 750 — 725 600 700
Issuer of report: HSBC Securities (USA) Inc. Source: HSBC

Disclaimer & Disclosures

This report must be read with the
disclosures and the analyst certifications
in the Disclosure appendix, and with the
Disclaimer, which forms part of it
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Contents

Bound to rebound 3 Platinum 40

Raising our platinum price forecasts 40
HSBC gold outlook 9 Heading moderately higher 40
Boosting our gold forecasts 9
Driving moderately higher 41
An ill wind blows good for gold 9
Supply trends: Looking flat 42
Gold should rebound 10
Demand trends 46
Geopolitics and gold 12

Macroeconomic influences 14 Palladium 52

Trends in supply and demand 21 Increasing our palladium price forecasts 52

Already high but may go higher 52

Silver 30 Start and stop 53
Lifting our silver price forecasts 30
Supply trends 53
Back to earth 30
Demand trends: Shifting gears 57
Recovery phase 31

Supply trends 34 Disclosure appendix 62

Demand trends 37
Disclaimer 63

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Bound to rebound
 Despite the steep pullback in gold, concerns about the inflationary
impact of highly accommodative monetary polices, deficit
spending, and high commodity prices should rekindle the rally
 Silver has retreated; investor sentiment will be crucial to price
direction; strong industrial demand is more than offsetting mine
supply growth but greater scrap supply may help weigh on prices
 PGMs are benefiting from growth in global auto production and
robust industrial demand; ETFs hold considerable metal

Gold economic and financial crisis, which began in

Increasing our gold price forecasts
Given the prevailing macroeconomic conditions and
gold’s proven utility as an inflation hedge, a safe-
haven instrument, and a portfolio diversifier, we are
raising our forecasts of average gold prices for:
 2011 to USD1,525/oz from USD1,450/oz.
 2012 to USD1,500/oz from USD1,300/oz.
 The long term (five years) to USD1,250/oz
from USD1,150/oz.
For 2013, we are introducing an average price
forecast of USD1,450/oz.
Cocktail of factors ushers gold to new
highs
The 10-year gold rally remains intact, despite the
recent steep pullback in prices. Prices had reached
a new high of USD1,575/oz as investors
continued to seek out bullion for its inflation
hedge and safe-haven qualities. The most virulent
phase of the gold rally can be traced to the global
mid-2007, and the subsequent unprecedented
monetary and fiscal responses. Investors’ appetite
for gold was increased by inflationary concerns
that were prompted by highly accommodative
monetary policies, including quantitative easing
and huge fiscal spending increases throughout
member states of the Organization for Economic
Cooperation and Development (OECD), and a
flight to safe-haven investments.
Easy accommodative monetary policies by the US
Federal Reserve stimulated already high demand
for commodities, notably – but not exclusively –
in the emerging world. In addition to higher oil
prices, agricultural prices surged, which prompted
the UN’s Food and Agricultural Organization to
declare a global food crisis earlier this year.
Commodity price rises fanned inflation fears and
stimulated demand for hard assets, including gold.
The eruption of popular discontent in the Middle
East, in particular the civil war in Libya, with
implications for oil supply disruptions, raised the
global geopolitical risk thermometer, which

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further buoyed gold. A report by the World
Economic Forum this year warned of rising global
geopolitical risks, growing income disparity,
increasing food prices, and the inability of the
world’s governments and institutions to fend off
another economic crisis with depleted resources.
All of these factors supported gold.
US fiscal profligacy also supported gold prices.
Continued heavy US government deficit spending
and warnings by the credit rating agency Standard
& Poor’s that the US must restrain its fiscal
spending have further galvanized investor demand
for hard assets, including gold.
Gold prices moved in an almost unbroken upward
trajectory for much of this year. A pullback in
early May was triggered by a correction in
commodity prices, notably oil, which, along with
a bounce in the USD and heavy liquidation by
investors, clipped cUSD110/oz off record-high
gold prices by the end of the first week of May.
Though steep, the pullback in prices dented rather
than reversed the gold rally, in our view. Longer-
term, we expect an eventual return to some type
of economic normalcy, and the consequent
winding down of heavy deficit spending and easy
monetary policies could signal an end to the gold
rally. Nonetheless, we believe that gold will
remain at elevated levels for several years, as
investors are likely to keep a portion of gold in
their portfolios for its diversification properties.
Investor demand now is the main driver for gold
pricing, while traditionally important physical
supply and demand components, such as jewelry
demand and mine supply, have recently exerted
little influence on day-to-day moves in the gold
price. The bulk of current investor demand for
gold has been channeled into gold exchange-
traded funds (ETFs). Despite modest liquidation
this year, the ETFs still hold considerable
amounts of bullion. The major gold ETFs contain
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about 2,040.4t of gold, or c80% of the world’s
annual production. This is down c28t from the all-
time high of 2,068.4t in ETF holdings reached
near the end of 2010. Should investors choose to
liquidate even a fraction more of these holdings, a
substantial amount of bullion could appear in the
markets in a short period, with a commensurate
impact on price.
The growth in investor demand also is evident
from the rapid rise in net long speculative
positions on the Comex. Although Comex longs
are down from the high for the year to date of
26.7moz reached in mid-April, they still exceed
24moz. Heavy long positions also hold the
potential for further investor liquidation, with a
threat to the near-term gold price. Demand for
coins and small bars have been very strong for
many quarters. Even accounting for the recent
pullback in prices, we question whether retail
investors will continue to purchase coins and bars
in such heavy volume. High prices appear likely
limit the retail demand for gold in this segment.
After many years as a contributor to supply,
central banks have swung to being net buyers. We
believe this is an important development that will
support prices going forward. The signatories of
the third Central Bank Gold Agreement (CBGA)
sold little gold in the compact’s first year, through
end-September 2010. Central bank sales have
been similarly low so far this year. Most of the
major holders of gold in the CBGA, such as
Germany’s Bundesbank and Swiss National Bank,
have signaled a reluctance to sell. Meanwhile,
some emerging-market central banks have shown
an increased appetite for gold. The International
Monetary Fund announced an end to their sales
program at the end of 2010.
High prices are also having an effect on more-
traditional participants in the gold market,
encouraging an increase in recycled gold supplies
and creating significant financial incentives for
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producers to increase output wherever possible.
High prices may also curb jewelry demand, which
is still recovering from a near-collapse of demand
in 2009. Moderate jewelry demand and increases
in scrap and mine supplies will free up
considerable amounts of bullion for the
investment markets, we believe. This should also
eventually help cap any further rallies.
Silver
Increasing our silver price forecasts
We are raising our forecasts of average silver
prices for:
 2011 to USD34/oz from USD26/oz.
 2112 to USD29/oz from USD20/oz.
 The long term (five years) to USD20/oz
from USD15/oz.
For 2013, we are introducing an average price
forecast of 24/oz.
Silver roller coaster
Before retracing heavily at the beginning of May,
silver had rallied from USD18/oz in September
2010 to 31-year highs near USD50/oz by late
April 2011. Just as the case for gold, silver prices
have benefited from demand for hard assets
stemming from the 2007-09 financial crises and
the monetary and fiscal responses. The most
recent phase of the silver rally coincided with the
Fed’s signal in August 2010 that it would
reintroduce quantitative easing, in which lending
programs are financed by the Fed’s balance sheet,
essentially creating and using cash to finance
lending facilities.
For investors interested in hard assets, such as
gold, silver has a similar attraction based on
growing inflation concerns, higher commodity
prices, and elevated geopolitical and sovereign
risks have spurred demand.
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Silver prices gained noticeably on gold for much of
the past year. The silver/gold ratio moved from 68:1
at end-April 2010 to 30:1 one year later, marking the
lowest point since the early 1980s. The recent
correction in silver which drove prices back down to
USD34/oz, also buoyed the ratio back to 42:1.
Although this indicated a growing preference among
some investors for silver over gold, we believe that
the ratio is likely to increase as investors recognize
that silver has become too expensive relative to gold
and reverse their positions. Indeed, the silver/gold
ratio increased at the beginning of May to 42:1.
Meanwhile, in early May, silver prices pulled back
to USD34/oz in the days after the CME Group, the
Comex operation, announced margin increases,
which triggered heavy long liquidation, and a wider
retreat in commodity prices.
The earlier surge in silver prices came in tandem
with a modest increase in holdings by silver
exchange-traded funds (ETF). The combined
holdings of all three ETFs – the Barclays iShares
and the smaller ETF Securities and the Zurich
Kantonalbank Bank (ZKB) – increased by
c9.0moz to 467moz on 30 April 2011 from
457.9.6moz on 1 January 2011. Since then,
investors liquidated a substantial 16moz, taking
ETF holdings down to 451moz. Sales of coins and
small bars remain vigorous, following on from
robust levels in 2010.
We forecast that the silver market will be in
surplus this year due in large part to increases in
scrap and mine supplies. Substantial investments
in silver mine projects earlier in the mining cycle
are bearing fruit. Also, a greater supply of base
metals will increase the silver byproduct supply,
we believe. In addition to growing mine output,
increased scrap recycling will contribute to silver
supply. As long as prices remain above
USD30/oz, we expect both individuals and
manufacturers to supply considerably more scrap
metal for recycling than in recent years.
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Increases in mine and scrap supplies will be offset
by robust industrial demand, we believe. More
than half of the annual silver supply is regularly
consumed by industrial sectors. High prices have
not yet deterred industrial demand for silver.
Based on HSBC’s macroeconomic forecasts for
global industrial production, we forecast
substantial increases in silver purchases by
industries this year.
Photographic demand for silver, meanwhile,
appears likely to extend its decline, as traditional
photography continues lose market share to less
silver-intensive digital cameras. The decline in
silver for photography has led to a corresponding
decline in recycled silver nitrates.
The recent pullback by silver prices is a closer
reflection of the underlying fundamentals, in our
opinion. Conditions in the global economy may keep
silver prices elevated and well above historical
averages this year and next year, in our view.
Platinum
Raising our platinum price forecasts
We are increasing our forecasts of average
platinum prices for:
 2011 to USD1,850/oz from USD1,750/oz.
 2012 to USD1,750/oz from USD1,650/oz.
 The long term (five years) to USD1,625/oz
from USD1,600/oz.
For 2013, we are introducing an average forecast
of USD1,650/oz.
Driving higher
Platinum prices rallied from a year-to-date low of
USD1,654/oz on 17 March 2011 to a high of
USD1,884/oz on 2 May. The price decline earlier
in the year was prompted by the earthquake and
tsunami in Japan and anxiety that global auto
production would be significantly disrupted,
limiting the need for platinum. After recovering
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from this decline, prices weakened again in early
May in tandem with a broad-based pullback by
commodities. We believe this latest platinum
price decline was triggered more by weakness in
other precious metals, notably gold and silver,
rather than a change in platinum’s underlying
fundamentals.
Based on our supply/demand model, we expect the
platinum market to remain in deficit this year. A
production/consumption deficit seems to be the
normal state of affairs for the platinum market.
According to our supply/demand model, the market
has been in deficit every year in this decade except
for 2006 and 2009, when auto and industrial
demand almost collapsed due to the global
economic crisis. As deficits continue, we expect the
platinum price to be increasingly well-bid.
The listing of a US platinum group metals (PGM)
exchange-traded fund (ETF) has been a notable
success, absorbing a significant amount of
platinum since its launch at the beginning of the
2010. Last year, the combined holdings of the
four major platinum ETFs jumped by 555,000oz
to 1.126moz. This year so far, combined platinum
ETF demand is up by 145,000oz to 1.271moz.
The demand has been driven by the same factors
that propelled investor interest in hard assets in
general, namely, concerns about potential
inflation, the direction of the USD, heavy deficit
spending by governments, loose monetary
policies, and geopolitical tensions. Despite the
recent pullback in the platinum price, these factors
appear likely to support platinum ETF demand for
the rest of this year. If appetite for the ETFs
should dim and investors choose to liquidate even
a fraction of their holdings, the market could
move into surplus, according to our
supply/demand model, with a commensurate
impact on prices.
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The automotive industry is the single largest
demand source for platinum, where the metal is a
necessary input in construction of autocatalysts
and particulate filters. The industry’s demand for
platinum soared in 2010 in line with the global
recovery in auto production following a near-
collapse in 2009. Based on HSBC equity research
by the automotive team, we expect platinum
demand from the auto industry to increase at a
more modest pace this year as growth in auto
production decelerates. HSBC equity analysts
forecast that growth in global auto output will
slow in 2011 but remain positive.
Other forms of industrial demand for platinum,
including electronics, glass, chemicals, and
petroleum refining, are growing at a brisk pace.
Based on HSBC macroeconomics forecasts of a
continued recovery in global industrial demand in
2011, we expect industrial demand for platinum to
remain robust but to grow at slightly lower
percentage rates, compared with 2010 levels.
We believe that demand for platinum jewelry in
2011 will decline modestly, based on high prices.
China accounts for the bulk of demand for
platinum jewelry, which remains very popular.
Chinese consumer income is rising rapidly, and
we believe that some demand response to high
prices is likely. In addition, we expect that high
prices will encourage jewelry recycling.
Meanwhile, producers in South Africa face
obstacles and challenges in raising platinum mine
output. These include power constraints,
availability of fresh water, labor costs, a strong
ZAR currency, and a variety of geological and
technical problems. High prices above marginal
costs and investment earlier in the cycle will
support a modest increase in production.
Similarly, we expect Russian platinum output to
increase modestly. A recovery in North American
output following poor production levels in 2010
will help boost mine supply.
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Palladium
Raising our palladium price forecasts
Following many years of heavy supply/demand
surpluses, the palladium market has moved into
deficit, where we believe it is likely to remain.
This will have a pronounced psychological impact
on the market, in our view, and will sustain higher
prices. Based on this, we are raising our forecasts
of average palladium prices for:
 2011 to USD825/oz from USD750/oz.
 2012 to USD750/oz from USD650/oz.
 The long term (five years) to USD700/oz
from USD600/oz.
For 2013, we are introducing an average price
forecast of USD725/oz.
Higher on tight supply
After recovering from a drop below USD380/oz
in early February 2010, palladium prices surged to
just above USD800/oz by the end of 2010. Prices
continued to climb this year, rising to a high of
USD859/oz by late February. They subsequently
dropped to a year-to-date low of USD690/oz on
17 March in response to the earthquake and
tsunami in Japan, which caused the suspension of
that country’s auto production and cast doubt on
the auto industry’s demand for palladium.
Influenced by a pullback in commodity prices
generally, palladium prices tumbled to
USD697/oz by 5 May.
Palladium has benefited from the recovery in
global auto production. The industry traditionally
absorbs more than half of annual palladium
production, required for production of
autocatalysts and particulate filters. Gasoline-fired
engines require substantially more palladium in
their PGM loadings than diesel-fueled vehicles.
Gasoline vehicles are favored in most of the
emerging world, notably China and India, as well
as in North America, where demand has been
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HSBC economic and metals price forecasts

2003 2003 2004 2005 2006 2007 2008 2009 2010 2011f 2012f Long term
G-7 IP % pa 1.0 1.0 2.6 1.9 3.5 3.5 -2.2 -12.9 6.9 4.1 4.2
Global IP % pa 4.6 4.6 6.3 5.3 6.3 6.3 1.5 -6.1 12.4 6.4 6.3
Aluminum USD/t 1,433 1,433 1,270 1,886 2,557 2,557 2,571 1,587 2,160 2,534 2,600 2,204
Copper USD/t 1,768 1,768 2,866 3,682 6,702 6,702 6,965 4,930 7,339 8,970 7,493 5.069
Nickel USD/t 9,634 9,634 13,845 14,749 24,052 24,052 21,070 14,727 21,665 25,434 22,04 15,428
Zinc USD/t 772 838 1,058 1,389 3,263 3,263 1,873 1,543 2,072 2,181 2,314 1,741
Aluminum USc/lb 61 65 78 86 116 116 117 72 98 115 118 100
Copper USc/lb 71 81 130 167 304 304 316 224 333 407 340 230
Nickel USc/lb 307 437 628 669 1,091 1,091 956 668 983 1154 1000 700
Zinc USc/lb 35 38 48 63 148 148 58 70 94 99 105 79
Gold USD/oz 210 364 410 445 604 604 872 990 1,225 1,525 1,500 1,250
Silver USD/oz 4.60 4.88 6.66 7.29 11.55 13.55 14.97 14.80 19.00 34.00 29.00 20.00
Platinum USD/oz 539 692 846 897 1,139 1,106 1,574 1,210 1,725 1,850 1,750 1,625
Palladium USD/oz 337 200 230 202 319 356 351 265 525 825 750 700
IP = Industrial production
Source: HSBC

relatively better than in the primary diesel-fueled The launch of a US-listed PGM exchange-traded
markets of Europe. The US and Chinese auto fund (ETF) by ETF Securities last year was highly
markets, together, account for the bulk of successful and is absorbing a significant amount
palladium autocatalyst demand worldwide. Based of available above-ground stock. Palladium ETF
on HSBC research forecasts of auto production, demand has been static this year. Industrial
we expect that auto industry growth in palladium demand has been robust, in keeping with the
consumption this year will moderate considerably recovery in global industrial production. Based on
from 2010 but remain positive. HSBC macroeconomic forecasts of continued
industrial expansion this year, we believe that
The overwhelming bulk of palladium mine
industrial off-take for palladium will increase. The
production is derived as a byproduct of platinum
combination of industrial demand and reduced
production in the case of South Africa and nickel
Russian stockpile sales has the potential to tighten
output in the case of Russia. Together, these
underlying supply/demand balances and maintain
countries make up the vast bulk of global
high prices for the rest of the year, we believe.
palladium mine production. By our calculations
and based on producer comments, both regions
should increase palladium output this year. Such
increases appear likely to be modest, however, as
producers face a variety of challenges, including
falling ore grades, inadequate infrastructure, and
constraints on power and fresh water. Also,
concern about the level of Russian palladium
stockpiles, and therefore the potential for a large
decrease in Russian exports, remains a factor.
Prices are well in excess of marginal costs of
production, however, and producers are making
every effort to increase output wherever possible.

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HSBC gold outlook

 Gold pulls back on commodity price correction after hitting record
highs on concerns about highly accommodative monetary
policies, deficit spending, USD weakness, and elevated
geopolitical risks
 Prices should remain elevated as investor demand offsets impact
of increased mine and scrap supplies and weak jewelry demand
 We are raising our average gold price forecasts and introducing
an estimate for 2013

Boosting our gold forecasts
We are raising our forecasts of average gold
prices for:
 2011 to USD1,525/oz from USD1,450oz.
 2012 to USD1,500/oz from USD1,300/oz.
 The long term (five years) to USD1,250/oz
from USD1,050/oz.
For 2013, we are introducing a forecast of
USD1,450/oz.
An ill wind blows good for gold
Despite the recent pullback in gold prices, we
remain positive on the metal going forward. Gold
prices will be determined largely by the interplay
between monetary policy, inflation expectations,
the direction of commodity prices, the evolving
sovereign debt crisis in the euro zone, similar
concerns regarding US debt levels and fiscal
policy, and geopolitical risks.

Gold prices, 1971-present (USD/oz) Gold prices, 2005-present (USD/oz)

1800 1,800
1600 1,600
1400 1,400
1200 1,200
1000 1,000
800 800
600 600
400 400
200 200
0 0
Apr-74

Apr-80

Apr-86

Apr-92

Apr-98

Apr-04

Apr-10

Apr-05

Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11

Source: Reuters Source: Reuters

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How confident investors will be in government to
remedy global economic and geopolitical
challenges, and the direction of the foreign
exchange markets, also will be important factors
in determining gold prices. In this atmosphere,
traditional supply/demand factors including mine
supply, producer hedging policies, and jewelry
and industrial demand may take a second place to
macroeconomic and geopolitical influences and
investment demand on gold. We believe that on
balance, these factors will keep demand for gold
elevated for the rest of the year.
As outlined by the HSBC macroeconomics team,
US monetary policy is likely to remain
accommodative, even after the end of the Fed’s QE2
program, scheduled for June. Meanwhile, inflation
fears based on surging commodity prices and loose
US monetary policy are increasing inflationary
pressures in the emerging world. This is supportive
of gold. Although core inflation is not rising in the
OECD nations, commodity inflation to which gold is
sensitive is increasing sharply. The food crisis
declared by the UN and popular uprisings in the
Middle East introduce a geopolitical dimension that
is further supportive of gold. Though the recent
pullback in commodity prices was steep, this does
not indicate a reversal in the long-running
commodity bull market, we believe.
Investment demand was firm for gold until May.
We believe that high prices contributed to the
decline in ETF and physical bullion demand. At
lower gold prices, ETF demand should recover.
Also, demand for coins and small bars implies
that retail and institutional demand is still
underpinning the gold rally.
Jewelry demand has risen from multiyear lows.
But the combination of high prices and economic
uncertainty will limit demand growth this year,
we expect. The continued recovery in gold
demand in the emerging world may be tempered
by high prices.
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The main source of physical supply, mine output,
is set to increase this year and next year, as high
prices encourage greater output and producers
increase reserves. Dehedging, an important source
of demand for a decade, is all but disappearing.
The official sector turned into a net buyer of gold
in 2010 after two decades of heavy sales. Central
banks appear likely to increase net purchases this
year in an effort to diversify their foreign
exchange holdings. This may be an important
bullish development for gold.
Gold’s status as a safe haven and portfolio
diversifier has been confirmed by the increase in
investor demand since the beginning of the
economic crisis. However, if US monetary policy
were to be tightened and commodity prices ease
and geopolitical tensions fall, the rationale for
owning gold would fall with a commensurate
impact on prices. The balance of factors argues
for higher, rather than lower, prices over much of
this year, in our view.
For gold, we anticipate a wide trading range this
year of USD1,300-1,650/oz , with a possible spike
to USD1,700/oz. At prices above USD1,500/oz,
we expect jewelry demand would weaken and
scrap supply increase. Conversely, we would
expect any price decline below USD1,300/oz to
encourage greater emerging-market demand for
bullion. The new dynamics for investors have
renewed their demand for gold as both a safe
haven and a hedge against inflation. Eventual
normalization of the global economy and ultimate
tightening of monetary policies explain our view
on gradual price declines from 2012 onward.
Gold should rebound
In 2010, the gold price rose for a 10th consecutive
year. The rally was driven by a recovery in some
sectors of physical demand and continued global
economic uncertainty. The gold price rose 29%
y-o-y to USD1,405/oz after hitting what was then
an all-time high of USD1,430/oz on 7 December
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2010. The average price for the year was since the onset of the subprime mortgage crisis in
USD1,225/oz, up from an average of USD973/oz mid-2007. Gold benefited from its stature as a
in 2009. Gold also outperformed all other major safe haven and its lack of counterparty and credit
asset classes and most other commodities. This risk as the initial subprime mortgage crisis
year, prices corrected to USD1,308/oz, a year-to- morphed in a full-blown credit and financial crisis
date low, on 28 January. We attribute this sharp with the collapse of Lehman Brothers in 2008.
but brief drop to a shift in investor sentiment.
Gold benefited further as governments and
Well-received Portuguese and Spanish bond
monetary authorities across the globe slashed
auctions and positive comments about the US
interest rates, boosted spending, and implemented
economy by US Federal Reserve Chairman Ben
unprecedented measures such as quantitative
Bernanke increased investor appetite for “riskier”
easing. Investor concerns shifted from
investments and triggered a flow out of gold.
counterparty and credit risk to anxiety that highly
Long liquidation on the Comex and a decline in
accommodative monetary policies and rising
the holdings of the largest gold-backed exchange-
government debt levels would inevitably bring
traded funds (ETFs) were visible signs of the
back high inflation rates. Gold remained a popular
change in investor demand. Gold would have
alternative to paper assets throughout 2009 as
penetrated USD1,300/oz, we believe, were it not
investors sought out bullion for its inflation hedge
for robust physical demand in Asia. Heavy
properties. Gold investment remained robust as
exports globally of bullion to China, India, and
the economic crisis developed into a sovereign
other parts of Asia from December 2010 through
risk crisis in 2010. A second round of quantitative
February this year not only sustained the gold
easing by the Federal Reserve gave gold a second
market when Western investor sentiment dimmed,
wind later in the year, helping to propel gold
but helped push the metal price to new highs later
prices to new highs.
in the year.
More recently, fiscal concerns and events in the
Bullion prices recovered in February, spurred by
Middle East have helped push commodity prices
accelerating commodity prices, notably oil. Rising
up, buoyed further by rapacious demand for
petroleum prices were tied to unrest in North
commodities in much of the emerging world. This
Africa and the Middle East. Regime change in
momentum led the surge in gold prices to record
Tunisia and Egypt, demonstrations throughout
levels above USD1,575/oz by early April. A price
that region, and civil war in Libya amplified safe-
correction took gold back to USD1,462/oz in
haven demand for bullion. Underpinning the rally
early May.
were concerns that popular discontent in the
Middle East would disrupt the smooth flow of oil The price correction has blunted – but not
from the region. A move into gold by investors reversed – the gold rally, in our opinion. For the
also was triggered by the aftermath of the rest of this year, we expect elevated geopolitical,
earthquake and tsunami in Japan in March, which inflation, and sovereign risks to support bullion
caused widespread destruction and significant prices. Longer-term, we anticipate an eventual
damage to nuclear plants that leaked radiation. end to the current highly accommodative
monetary policies. This could gradually undercut
Until the Mideast upheavals began, gold prices
the gold market as real interest rates rise and the
reflected closely the course of the financial and
safe-haven bid for gold diminishes. Increased
economic crisis. Prices have more than doubled
fiscal restraint by the world’s major economies

11
 Commodities
Global
10 May 2011
also should eventually curb gold rallies, but we
believe that heightened sovereign risk worries will
buoy gold prices in the near term. A flattening of
the US yield curve may be the most visible
expression of a tightening of monetary policy and
an easing by gold prices.
The following chart shows how well gold
performed in relation to other asset classes during
the economic crisis.
Gold: Safe haven among asset classes, 2008-end April 2011
Returns for Various Asset Classes 2008-Present
100.00%
80.00%
60.00%
40.00%
20.00%
0.00%
-20.00%
-40.00%
-60.00%
Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11
S&P 500 Gain (Loss) Gold Gain (Loss)
T-Note Gain or Loss Lipper Muni Index Gain (Loss)
Source: Reuters
Geopolitics and gold
In addition to reflecting the global economic and
financial climate, gold is a barometer of
geopolitical and even social risks. We believe that
the severity of these risks is increasing and is
likely to have a commensurate effect on gold
prices for the rest of this year.
In our 14 January research note, Golden Risks:
The World Economic Forum identifies major risks
to the world economy that may influence gold
prices, we discussed a WEF report, Global Risks
2011, which outlined economic and geopolitical
risks facing the global economy as assessed by
580 world leaders and decision makers. These
risks hold potential ramifications for gold. The
WEF found that the financial crisis had greatly
weakened economic positions of governments,
societies, and institutions, particularly in mature
economies. This has reduced the capacity of the
12
abc
world to absorb any major new shocks or meet
global challenges.
In addition to reducing overall global economic
resilience, the financial crisis has led to a rise in
geopolitical tensions and raised global social
discontent, according to the WEF, increasing risks
across a range of economic, geopolitical, social
and even climate categories. This is likely to mean
that economic and geopolitical events, even
relatively low-level events, may have an
exaggerated effect on gold prices, as governments
and institutions struggle to cope with fresh
challenges when they have depleted resources in
the wake of the financial crisis.
An additional factor addressed by WEF is the
interrelationship between risks, and its report
suggested that because of globalization, risks for
contagion have grown significantly. This might
hold important implications for gold prices.
Increased contagion is likely to boost gold’s
sensitivity to global economic and geopolitical
events and to make gold prices more volatile than
would otherwise be the case. This helps explain
our expectations of a relatively wide trading range
for gold prices this year of USD1,300-1,650/oz ,
with a possible spike to USD1,700/oz.
The WEF report identified economic disparity and
global governance failures as significant risks to the
world economy. The was confirmed by the World
Bank, which found that income inequality as
measured by the Gini Index, a traditional economic
measure of income inequality, over the past decade
increased most rapidly in emerging economies,
notably but not exclusively in India, China, and
Indonesia. Income inequality also increased across
the OECD world for the same period.
The growth in income inequality broadly
coincides with the long-run rally in gold prices.
During periods when income inequality is
relatively stable or narrowing, gold prices tend to
 Commodities
Global
10 May 2011
weaken. This could be because growing inequality
is often associated with rapid economic growth,
rising commodity prices, and sometimes higher
inflation. Narrowing income inequality tends to
occur against a backdrop of more-stable and less
inflation-prone periods.
Typically, economic disparity also is highly
connected to asset bubble collapses, fragile
governments, inefficient economies, corruption,
and general social immobility. Data collected by
the WEF suggest that economic disparity and
geopolitical conflict reinforce each other. Asset
bubble collapses, in particular, stimulate interest
in gold as a safe haven. According to the Council
on Foreign Relations, income disparity,
corruption, and social immobility are the principal
drivers of the wave of protests against
governments in the Middle East this year.
We found it interesting that gold prices dropped to
their low for this year of USD1,308/oz in mid-
January after well-received Spanish and Portuguese
bond auctions reduced euro sovereign risk. Gold
prices subsequently surged in response to the
popular discontent that began in Tunisia and quickly
spread to much of the rest of North Africa and the
Middle East. It is no coincidence that gold prices
have accompanied worries that the Libyan civil war
and popular discontent in the oil-producing Gulf
states would disrupt global oil supplies. The surge in
oil prices was crucial in preventing gold from
breaking below USD1,300/oz earlier this year. Oil
prices have spurred higher gold prices before,
notably in the 1973-74 and 1979-80 energy crises.
We visit the impact of commodities on gold
throughout this report.
History has shown that gold prices are sensitive to
geopolitical and social dynamics, as well as
economic and financial events. The WEF report
stated that the severity of these risks is increasing,
and we believe this is likely to have a commensurate
effect on gold prices for at least the rest of this year.
abc
The intensity of geopolitical challenges and how
they are faced will help dictate the direction of gold
prices. The US National Intelligence Council, a
center for strategic thinking, and the European
Union’s Institute for Security Studies recently
concluded that current frameworks for international
cooperation leave the world ill-equipped to keep
pace with mounting geopolitical challenges without
extensive reform. This implies that geopolitical risks
will continue to bolster gold prices.
The golden ghost of Malthus
The Reverend Thomas Malthus, a British scholar,
is regarded as one of the founders of political
economy. In “An Essay on the Principle of
Population” (1812), he postulated that population
growth was exponential but that agricultural
growth was arithmetic. Thus, any sharp rise in
population would eventually lead to a food
shortage, which would ultimately be self-
correcting. To date, technological and scientific
advances and rising productivity have prevented
Malthus’s prediction from coming true.
Malthus’s theories have been amplified and
applied to natural resources, and they are
periodically revived, typically triggered by fears
of too-rapid depletion of world resources. These
periods usually coincide with prolonged bull
markets for gold. The last such period was the
1970s, when the world was rocked by food and
energy crises. The Club of Rome, a global think
tank, produced in 1972 a now-famous report,
“The Limits to Growth,” which attempted to
model the consequences of a rapidly growing
world population and finite resource supplies. The
dominant thesis later in the 20th century was that
the market would always solve the problem – high
prices would encourage technological advances,
and producers would find new sources of supply.
This view generally coincides with low or stable
gold prices.
13
 Commodities
Global
10 May 2011
The rise in per capita commodity consumption in
the developing world, brought on by rising
prosperity, has led to unprecedented demand for
commodities. Fears of depletion of natural
resources again have taken center stage.
Escalating commodity prices and worries that the
world is depleting the stock of natural resources is
encouraging demand for hard assets, including
gold. This is likely to remain the case for as long
as commodity prices remain elevated, we believe.
As gold is a commodity and a traditional hedge
against inflation, its prices have been strongly
influenced by the steep rise in commodity prices.
The charts overleaf show how prices of metals
and food have risen over the past few years. We
believe that it is no coincidence that the increases
in prices of metals and foodstuffs have broadly
coincided with the long-running rally by gold.
Food price increases have created social discord
and raised political tensions across the emerging
world, where consumers spend a significantly
higher proportion of their incomes on food than in
the developed OECD member states. This also is
a contributing factor in the outbreak of popular
unrest in North Africa and the Middle East. The
combination of rapid increases in population and
growing prosperity leading to higher per capita
incomes is putting unsustainable pressures on the
world’s resource base, according to the most
recent report by the UN’s Food and Agricultural
Organization (FAO).
The FAO earlier this year declared a global food
emergency, mostly in response to droughts in
Russia, Ukraine, and Kazakhstan, a suspension of
grain exports from Russia, and flooding of grain-
producing regions in Australia, all of which hurt
grain harvests. The FAO had last declared a food
emergency in 2008. The withdrawal of food
subsidies across much of the emerging world at
that time sparked food riots in more than a dozen
countries and coincided with a robust gold rally.
14
abc
The FAO also identified shortages of clean water
and fertilizer, high energy prices, and a lack of
investment as chronic impediments to increasing
food output. Any resource-driven crisis, even if it
is one of a relatively small scale, typically is
likely to be supportive of gold prices.
An increasing share of global GDP is generated in
the emerging world. A feature of economic
growth in these nations is a growing appetite for
commodities. As these nations continue in a
commodity-intensive phase of development,
HSBC macroeconomics expects commodity
demand to remain high. Meanwhile, increases in
income are triggering a change in diets, notably a
switch from carbohydrates and vegetable protein
to animal protein. This is putting pressure on the
world’s grain supplies and increasing agricultural
prices. We regard the rise in food and other
commodity prices as an important element in
gold’s rally. And for as long as food prices are
likely to remain high, they will be a bullish factor
in determining gold prices, we believe.
Macroeconomic influences
Economic challenges good for gold
In Global Economics Quarterly: An economic oil
slick (31 March 2011), HSBC chief economist
Stephen King and the macroeconomics team
stated that just as the global economy was picking
up steam, the world was presented with a new set
of challenges. Commodity-inspired price gains
were threatening the economic recovery in the
developed world while contributing to heightened
political instability in parts of the emerging world.
In our opinion, the combination of rising
commodity prices, increased inflationary
expectations, and elevated geopolitical risk is
tailor-made for a gold rally, and largely explains
that market’s ascent to new highs.
 Commodities
Global abc
10 May 2011

Metals prices have risen sharply Foodstuffs: Recent price increases eclipsed those in 2008

Index , 2004=100 Index , 2004=100 Index , 2004=100 Index , 2004=100

450 450 220 220
400 400 200 200
350 350 180 180
300 300 160 160
250 250 140 140
200 200 120 120
150 150 100 100
100 100 80 80
50 50 60 60
0 0
00 02 04 06 08 10
00 02 04 06 08 10
Metals Foodstuffs

Source: Thomson Reuters Datastream Source: Thomson Reuters Datastream

One reason the commodity rally has had such a
bullish impact on gold is the timing of the
commodity upswing. Mr. King pointed out that
never before had there been such a large increase
in the cost of raw materials so soon after the end
of a deep and protracted recession impacting most
of the Western world. The suddenness of the
commodity rally changed inflationary
expectations, according to Mr. King, thereby
contributing to demand for gold as an inflation
hedge. Such a large rise in commodity prices also
could puncture business and consumer
confidence, Mr. King said. If so, we would expect
gold to be a beneficiary. The recent pullback in
commodities, while steep, is not of sufficient
magnitude to allay inflation fears, especially if the
retreat proves to be short-lived in the near term.
According to the HSBC economics team, this
approach has been partly successful. Asset prices
have recovered, and consumer and business
confidence has risen. But while low interest rates
and easy credit have led to a rebound in activity in
the developed world, it has stimulated far greater
growth in the emerging world. Unlike the situation
in the developed world, emerging economies are
not shackled by debt. As a consequence, they have
responded vigorously to easy global monetary
conditions. The vitality of emerging nations,
combined with investor unease about the printing
of money, has led to increased demand for
commodities and other non-paper stores of value,
such as gold. This helps explain the heavy demand
for gold in both the emerging and developed
worlds and the resulting price rally.

Unorthodox policies help gold
In an effort to stave off a repeat of the Great
Depression and jump-start their economies,
Western central banks have pursued highly
accommodative monetary policies. These include
unconventional policies, including a huge increase
in bond purchases via an expansion of central
bank balance sheets. Fear of the inflationary
consequences of these policies has stimulated the
demand for gold.
The rise in commodity-led inflation has led
financial markets to begin to price in an increase
in interest rates. Some OECD central banks,
including the European Central Bank, have raised
rates, and prospects have diminished for an
extension of the second round of the Federal
Reserve’s quantitative easing program, scheduled
for 30 June, according to the HSBC economics
team. Despite this, monetary policy in Western
economies remains highly accommodative and is
still gold-supportive.

15
 Commodities
Global abc
10 May 2011

The experience of emerging nations is different, Oil prices are sensitive to small fluctuations in supply

according to Mr. King. The focus on inflation in USD World oil price USD
140 140
these countries is more pronounced, particularly Lower P ro duction
120 120
given the effects of inflation on the less well-off. The
100 100
rise in commodity prices has hastened a tightening Feb base
80 80
of monetary policies in the emerging world. 60 60
Emerging nations have favored unconventional 40 40
tightening policies, including “quantitative 20 20
tightening” and a clampdown on domestic credit, in 0 0
addition to conventional rate increases. 2005 2007 2009 2011 2013 2015

The Chinese authorities have employed a Source: Oxford Economics, HSBC

combination of reserve requirement increases and

economic uncertainty. Oil prices are very
supply-side measures aimed at cooling food
sensitive even to slight disruptions in supply. The
prices, according to the HSBC economists. These
chart immediately above forecasts the effects of
authorities have repeatedly raised reserve
tight supply on prices.
requirement ratios in an effort to soak up excess
liquidity, and growth of the broad money supply Between the rise in oil prices and the disaster in
and new loans has eased since the Chinese central Japan, the biggest threat to the world economy is
bank began its tightening policy. Other emerging- higher oil prices, according to the HSBC
market central banks are monitoring China’s economics team. This is also positive for gold.
success in managing inflation and may follow Higher oil prices lead to a redistribution of global
suit, according to the HSBC economics team. If income away from oil-consuming but high-
the Chinese authorities fail to rein in inflation, spending economies such as the US and toward
gold is likely to be a beneficiary. oil-exporting and high-saving nations such as
Saudi Arabia. The propensity in oil-consuming
The Middle East shock, oil, and gold
countries to purchase gold is high and increases
Unrest in North Africa and the Middle East has
with higher oil prices. More important, perhaps,
buoyed oil prices. As with other commodities, the
the wealth transfer from higher oil prices leaves
rapid rise in oil prices comes shortly after the end
oil producers with excess savings, which can be
of a stiff recession. Typically, oil prices do not
invested elsewhere in the world. In a period of
rise until years into an economic recovery. The
economic and political uncertainty, there is likely
recent correction in oil prices of USD10 per barrel
to be a flight to hard assets, including gold.
to USD95, though steep, still leaves prices
historically high. Higher oil prices also lead to losses of business
and consumer confidence and changes in
According to the HSBC macroeconomics team,
inflation, which increase safe-haven demand for
the impact on oil prices, caused in part by the
gold. The rise in oil prices, which can act like a
uprisings in the Middle East and North Africa and
tax in oil-consuming nations, may lower incomes
the risk of economic dislocation following the
and curb discretionary spending on luxury items
earthquake and tsunami in Japan, threaten the
such as gold jewelry. In this regard, higher oil
world economy with a near “perfect storm.”
prices may be negative for gold demand.
These upheavals have greatly benefited gold by
increasing inflation concerns and elevating

16
 Commodities
Global abc
10 May 2011

Gold and the US Treasury yield curve Gold and the US debt-to-GDP ratio (USD/oz)

1600 3.5 1,800 90%

1400 3.0 1,600
80%
1200 2.5 1,400
1000 2.0 1,200 70%
800 1.5 1,000
60%
600 1.0 800
400 0.5 600 50%
200 0.0 400
40%
0 -0.5 200
0 30%
Apr-01
Apr-02
Apr-03
Apr-04
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apr-10
Apr-11

Apr-71
Apr-75
Apr-79
Apr-83
Apr-87
Apr-91
Apr-95
Apr-99
Apr-03
Apr-07
Apr-11
Gold (USD/oz) - LHS 10yr - 2yr (% ) - RHS
Gold (LHS) US Gross Federal Debt as a % of GDP
Source: Reuters
Source: Reuters, Congressional Budget Office

A monetary conundrum is good for Fiscal concerns are good for gold
gold
We discussed the bullish impact of the eruption of
As discussed in previous editions of our Precious the euro sovereign-risk crisis on gold in our 14
Metals Outlook, inflation expectations and May 2010 report, Precious Metals Outlook:
monetary policy wield enormous influence on Golden sovereign (risk). Gold is benefiting from
gold prices. Although the European Central Bank deepening government deficits and accommodative
recently raised rates and countries in the emerging monetary policies. If investors believe the
world are pursuing various forms of quantitative authorities are using fiscal policies excessively, this
tightening, the US Federal Reserve is unlikely to poses a significant risk of rising uncertainty in the
tighten monetary policy, according to the HSBC private sector. One channel for this uncertainty is
economics team, even if it does not extend its
likely to be the gold market.
second round of quantitative easing (QE2) and
chooses instead to maintain an accommodative Concerns about mounting government debt levels
monetary policy for the foreseeable future for fear are not limited to the peripheral euro-zone
of setting off a recession in light of substantially nations. Gold has attracted significant safe-haven
higher oil and other commodity prices. buying in the wake of action by Standard &
Poor’s; though S&P affirmed its AAA credit
The chart at upper left shows that as the US rating on US sovereign debt, it revised its long-
Treasury yield curve steepened, gold prices had a term outlook to negative from stable. Sovereign
tendency to rally. risk concerns are supportive of gold prices. At the
The conundrum facing US monetary policymakers is height of the Greek crisis in May 2010, German
that if they tighten policy, they may be criticized for banks sold a record number of gold coins, and
acting prematurely and possibly snuffing out gold prices surged above USD1,200/oz. Even
economic recovery. If they leave interest rates low, small countries with sovereign debt problems can
they may be blamed for stirring up inflation and have a positive effect on gold. With a GDP of
boosting commodity prices. Given the history of oil USD330.78bn, according to the latest national
price-related recessions in the US, the Fed is more figures, the Greek economy is roughly the size of
likely to choose to keep rates low for the foreseeable that of Washington state, which has a GDP of
future, according to HSBC Economics. This would USD338.33bn, according to the latest US data.
likely extend further support to the gold rally.

17
 Commodities
Global abc
10 May 2011

The chart at the top right of the previous page HSBC currency research team outlined the lack of
shows that as the US debt-to-GDP ratio moved a clear positive choice among the Big Four
above 60%, the gold rally accelerated. The chart at currencies: the USD, EUR, GBP, and JPY.
the bottom of this page shows the increase in US
Gold seems to be one of the “Cinderellas” in the
government liabilities. A change in the credit
currency “ugly sister” contest. In a pre-crisis
rating of the US, the world’s largest economy and
world, the foreign exchange market would likely
home of the world’s reserve currency, could be
be looking to sell the USD, Mr. Bloom said, based
“risk-sapping event,” according to HSBC chief
on US economic fundamentals. However, the
US economist Kevin Logan and G-10 currency
situations in Portugal and Ireland, as well as
analyst Robert Lynch. In a research note, Messrs.
Greece, mean that it is difficult to turn naturally to
Logan and Lynch outlined the long-term fiscal
buy the EUR. Meanwhile, the UK has its own
problems faced by the US: The federal deficit is
fiscal problems. The JPY is not a good candidate
likely to average about 7% of GDP for the next
for purchase due to recent coordinated
three years. On current trends, the US debt-to-
intervention by the Group of 7 nations. The
GDP ratio will surpass 90% by the end of this
unintended consequences, the HSBC currency
decade. In addition, interest payments on debt
research team said, are that the market is bullish
outstanding are likely to rise to 20% of federal
on currencies of OECD and emerging-market
revenues, making any long-term solution to the
commodity-producing nations and the CHF. Gold
deficit problem that much more difficult to
and currencies of EM and OECD commodity-
achieve. It is the financial market’s reduced
producing countries have had a positive
confidence that a long-term solution to the debt
correlation going back well before the financial
problem will be found that has helped propel gold
crisis. In this climate, appreciation of these
to new highs.
currencies would benefit gold. Strength in these
The ugly sisters’ currencies and currencies also helps explain some of gold’s rally.
Cinderella’s golden slipper The chart overleaf shows what the HSBC
In Currency Outlook: The ugly contest turns currency research team describes as the smaller
uglier (7 April 2010), David Bloom and the OECD “good currencies” versus the four major

US government debt outstanding has doubled since 2004

USD bn US Gov ernment Debt Outstanding USD bn

16,000 16,000
14,000 14,000
12,000 12,000
10,000 10,000
8,000 8,000
6,000 6,000
4,000 4,000
2,000 2,000
0 0
1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010

Source: Bloomberg, HSBC

18
 Commodities
Global
10 May 2011
Gold tends to move positively with “good” currencies
Good versus Ugly currencies trade weighted (Jan 1 2009=100)
124
Ugly contest currencies (USD, EUR, GBP and JPY)
120 Good currencies (AUD, NZD, CAD, NOK, SEK and CHF)
116
112
108
104
100
96
Jan-09 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Nov-09 Jan-10 Mar-10 May-10
Source: HSBC currency research, Bloomberg
“bad currencies.” The team defines “good”
currencies as traditional safe havens and those of
commodity-exporting countries and “bad”
currencies as the four most heavily traded OECD
currencies (see the chart immediately above).
Even if the US economy begins to recover and the
Fed starts to unwind some of its ultra-
accommodative policies, a sustained USD rally
should not be expected, Mr. Bloom said.
According to the currency team’s analysis, if the
US economic recovery accelerates, then the US
current account deficit will start to start to widen
again. This implies that overseas investors will
acquire yet more US assets at an increasing rate,
and it may well be that this can be achieved only
if US assets are made less expensive through a
weaker dollar. Based on the historical dollar/gold
inverse relationship, a weaker USD is a long-term
recipe for strong gold prices.
Macroeconomic themes
The currency markets are supportive of gold.
Each of the major four freely traded currencies –
the USD, EUR, GBP, and JPY – has its own
drawbacks. This makes gold – a widely accepted
abc
124
120
116
112
108
104
100
96
Jul-10 Aug-10 Oct-10 Dec-10
surrogate currency – and emerging-market
currencies a viable alternative for investors.
If history is any judge, the decade-long gold rally
will not end until the Federal Reserve changes
current accommodative policies, the USD
stabilizes, and progress is made on reducing the
US government budget deficit and restraining
growth in the debt-to-GDP ratio. Lower
commodity prices and a reduction in geopolitical
tensions also would help take the steam out of the
gold market. Conversely, any further decline in
investor confidence regarding monetary and fiscal
policies is likely to translate into higher gold
prices. Also, as commodity prices resume their
advance and geopolitical risks remain elevated,
investors are likely to return to gold, we believe.
Commitments of Traders reports still
show a commitment to gold
In the Commitments of Traders reports issued by
the Commodity Futures Trading Commission, net
speculative long positions in gold, in our view,
have been a reliable barometer of investor
attitudes toward the metal. Speculators have been
net long gold on the Comex since the genesis of the
bull market in 2001. Despite being overall net long,
19
 Commodities
Global abc
10 May 2011

positions are often subject to considerable volatility speculative liquidation. Between early December
and fluctuations, which can visibly affect gold 2009 and early February 2010, net long
prices. We believe this helps explain gold’s speculative positions fell from a record 30.8moz
price volatility. to 21.3moz, a decline of 9.5moz in just three
months. This is equivalent to 295t of gold, more
Net long speculative activity in 2010 reflected
than the annual output of Australia, the world’s
price movements for that year. Net long positions
second-largest gold producer. The liquidation
hit a low for the year of 21.3moz in the week of 9
helped drive gold from a then-record high of
February. This coincided with the low for gold
USD1,226/oz to below USD1,150/oz. A similar
prices that year of USD1,043/oz, touched on 5
liquidation occurred between November 2010 and
February. Both prices and net long speculative
January this year with a commensurate effect on
positions recovered notably thereafter. Net long
prices. Net long speculative positions fell from
speculative positions reached 30.3moz – just
30.3moz to 19.3moz, a decline of 10.7moz, as
800,000oz below the record high – the week after
prices dropped from a high of USD1,430/oz in
gold hit a then-record high of USD1,270/oz on 21
early December to USD1,308/oz by the end of
June. Long positions fell to 21.9moz by late July,
January. More recently, a 2.7moz in net long
in line with a drop in price below USD1,200/oz to
speculative positions from 19 April to 3 May
USD1,157/oz. Net long positions rebuilt
helped knock gold off its record highs and down
thereafter, peaking at 30.3moz in late September.
cUSD100/oz.
Long speculative positions eased moderately in
the following months but remained historically Even with the recent decline in net long positions,
high, touching 27.9moz when gold hit the then- the sheer size of these speculative positions may
record high of USD1,430/oz in early December. invite further temporary bouts of liquidation, with
the commensurate effect on prices, the long-
Early this year, changes in net long speculative
running accumulation of long positions clearly
positions reflected the steep drop in prices. Net
coincides with the multiyear bull market. We
positions fell throughout January, dropping to
believe the increase in net longs has played an
19.3moz by the end of the month, just as gold hit
important role in gold’s record-breaking rally, is
its year-to-date low of USD1,308/oz. Since then,
consistent with an increase in demand for safe-
net speculative long positions have grown by
haven assets, and reflects heightened investor
more than 6.6moz to 26.6moz, as prices surged to
uncertainty. The following chart shows the
all-time highs toward the end of April. The latest
combined ETF and net long speculative positions.
data showed a reduction in net longs to 24.0moz
as of 3 May, as gold prices retraced more than Gold: ETF and net speculative positions
USD100/oz, after reaching a record high. 1700 120
1500 100
Net long speculative positions represent about 1300
80
c747t of gold, a little less than one-third of global 1100
60
900
mine output. Net long positions have been 40
700
historically high for many months, staying well 500 20
above 20moz since July 2009, with the exception 300 0
Apr-04
Oct-04
Apr-05
Oct-05
Apr-06
Oct-06
Apr-07
Oct-07
Apr-08
Oct-08
Apr-09
Oct-09
Apr-10
Oct-10
Apr-11

of just two weeks in January this year. As net long

speculative positions remain at such high levels, Spec position in COMEX (RHS) Gold in ETFs (RHS)
Gold Price Usd per oz (LHS)
the sheer weight of long positions may encourage
Source: HSBC, Gold Bullion, ETF Securities, CFTC

20
 Commodities
Global
10 May 2011
ETFs: Don’t be fooled by liquidation
A notable feature of the gold market has been the
popularity of gold exchange-traded funds (ETFs)
with investors. Despite liquidation this year, the
ETFs continue to hold a substantial amount of
bullion. Of the 10 gold ETFs that we monitor,
combined off-take as of 6 May stood at 2,040.4t
of gold, or c80% of the world’s annual production
of gold. This is down c28t from the all-time high
of 2,068.4t in ETF holdings reached near the end
of 2010. The low in ETF holdings year-to-date is
1,980.5t, plumbed on 24 February.
A feature of the gold ETFs this year is an increase
in volatility. We do not view the liquidation in
ETF holdings – modest as it is – as necessarily
bearish. We believe some of the liquidation may
be attributed to investors’ switching into allocated
accounts and other forms of bullion holdings.
Thus, the declines in the ETFs do not represent an
overall drop in gold investment.
Despite an increase in volatility, swings in
holdings from the gold ETFs are still modest by
comparison with the Comex. Traditional futures
and options trading is typically more volatile and
more subject to short-term fluctuations than ETF
trading. This can make swings on the Comex
more influential in determining short-term price
movements than the ETFs, despite the Comex’s
considerably smaller market position.
ETF holdings notably overshadow long positions
on the Comex. Comex longs are little changed on
the year and account for about 747t, while ETF
demand is down c28t at 2,040.4t from the
beginning of the year. Though the pace of demand
may be slackening, gold ETFs still account for the
equivalent of more than c80% of global annual
mine output. In aggregate, the ETFs also are the
sixth-largest holders of gold in the world, behind
the central banks of the US, Germany, France, and
Italy, and the International Monetary Fund.
abc
Combined ETF and Comex holdings are the
equivalent of 2,787t of gold, or about the level of
annual mine output. We anticipate that demand
for allocated gold and other sources of bullion
may limit any increase in ETF off-take to c230t
this year. After increasing to a record 1,360t in
2009, total investment demand in 2010 edged
down to 1,297t, by our calculation. We forecast
this may fall to USD1,100t this year. Despite the
decline, investment demand remains high on a
historical basis. We believe that based on investor
concerns, demand for ETFs and coins and bars
will be sufficient to help usher gold prices higher
this year. That said, at substantially higher gold
prices, demand for these products could moderate,
and this should help cap rallies.
Trends in supply and demand
Gold supply: Producers dig high prices
With gold prices significantly above costs of
production – and likely to remain so for the
foreseeable future, we believe – producers have
an enormous financial incentive to increase
output. Despite a more than doubling in the gold
price in less than four years, production only
recently surpassed that in the banner year of 2001.
According to the GFMS precious metals
consultancy, gold production in 2001 totaled
2,646t. In the most recent “World Demand
Trends” produced by GFMS for the World Gold
Council, 2010 output was tabulated at 2,659t. We
estimate that additional gains this year will push
production further above 2001 levels.
Producers have had to contend with challenges
contributing to sluggish output. We have
examined these obstacles in greater detail in
previous editions of our Precious Metals Outlook.
They include a chronic shortage of skilled and
technical personnel, notably geophysicists,
geologists, and mining engineers; long waiting
times for essential equipment; declining ore
grades and dwindling reserves in the mature
21
 Commodities
Global abc
10 May 2011

producers; and longer permitting and regulatory Gold mine production (metric tons)

processes. Power constraints and a lack of fresh 2800

water also are curbing production notably – but 2700
not exclusively – in South Africa. Although the 2600
global financial and economic crisis has helped 2500
contain certain cost pressures, prices of key 2400

inputs, notably cement, steel, power, and fuel, are 2300

rising again. 2200

2001 2003 2005 2007 2009 2011f
Prices remain comfortably ahead of costs. This
Source: GFMS, WGC, HSBC
has allowed producers to absorb increases in
costs, while maintaining production at higher
gold-producing regions have spurred a new wave
levels than would otherwise have been the case.
of investment in other regions, leading to growing
Projects that would have been rejected as too
mine supply in other parts of the world.
expensive just a few years ago were deemed
Furthermore, in their 4 May 2010 report, African
feasible as gold prices climbed to new highs.
& CIS gold miners: Takeaways from reserve
Despite these obstacles, we anticipate further gold replacement trends in 2009, the analysts found
output gains this year. More production is that a majority of gold mining companies in and
scheduled to come on stream, as investments outside of HSBC’s gold equities coverage have
made earlier in the mining cycle translate into been able to replace ounces mined with the help
greater output. Until now, the long lag time of higher gold prices.
between investment and output has prevented a
The renaissance in production is likely to be
meaningful production response to high prices.
temporary, we believe. Producers still have to
High gold prices also have led to the restart of
contend with a host of challenges that will
operations that were on care-and-maintenance
inevitably limit production. Based on current mine
schedules and have encouraged producers to bring
production schedules, global production is likely
forward production schedules wherever possible.
to peak around 2014 and ease gradually thereafter.
Based on available company data, we expect
Long-term declines in output due to falling
production this year will grow by c90t, or c4%, to
reserves will be most pronounced in the mature
2,750t. This represents a 25t increase from our
and developed producers, notably South Africa,
previous 2010 forecast of 2,725t. We believe there
the US, Canada, and Australia.
are sufficient projects in the works to boost gold
mine output until 2014. The chart above right A slow climb
shows gold mine production. According to US Geological Survey (USGS) data,
the majority of all the gold ever produced has
In previous editions of our Precious Metals
been mined since 1900, with the bulk of this
Outlook, we examined work by Sabrina
production coming from just four countries: South
Grandchamps and Lucia Marquez, HSBC equity
Africa, the US, Canada, and Australia. A feature
research analysts in metals and mining, on the
of the market has been the relative decline in
effect of higher prices in investment and reserves
production in these traditional producers. In
replacement. According to these analysts’ report,
particular, falling grades and difficulties in
Global Metals & Mining: From Safari to Siberia
replacing reserves have limited output from these
(28 March 2009), declining trends in traditional

22
 Commodities
Global
10 May 2011
traditional producers. In the next couple of years,
we believe, aggregate world production will rise;
this includes production from some traditional
producers. Following is a discussion of the near-
term outlook for some of the larger producers.
US: The USGS survey estimates that US gold
mine production in 2010 grew c3% to 230t,
compared with 223t in 2009. This marked the first
increase in domestic production since 2000.
Increased production from new mines in Alaska
and Nevada and from existing mines in Nevada
accounted for much of the increase. These
increases were partly offset by decreases in
production from mines in Montana and Utah. US
production may increase c2% this year to c235t,
as production from Barrick Gold’s Cortez Hills
project in Nevada approaches full capacity.
South Africa: Output in South Africa, formerly
the world’s largest gold producer, fell 6.4% in
2010 to 191,833.7 kg, according to the South
African Chamber of Mines. Production costs are
relatively high due to the strong ZAR and the
expenses involved in running the world’s deepest
mines, some of which are 4 km below the surface.
Additionally, grades are generally low, compared
to most other large producers, and labor costs are
high by international standards.
Safety-related stoppages have also hindered
production. Recent calls for the nationalization of
the mines by the youth wing of the ruling African
National Congress (ANC) – although rejected by
the senior party leadership – has nonetheless had
an adverse impact on international investment in
the gold mining industry. New production at deep
mines in the Free State and West Rand will offset
closures from aging facilities this year. According
to Statistics South Africa, gold production in
February declined 2.3% annually, following 3.2%
growth in January. Statistics South Africa issues
changes only in percentage terms. Despite
evidence that output is bottoming, it will be
abc
difficult for the industry to arrest the long-running
trend of output declines.
Russia: Russian gold companies produced 19.98t
of gold in the first two months of 2011, up 13.9%
from a year earlier, according to the Gold
Industrialists’ Union. Mined output in January-
February increased 12.6% from the year-earlier
period to 16.38t. Output of gold as a byproduct of
other metals increased by a substantial 95.1% to
12.27t, while refining from scrap was essentially
unchanged at 2.37t, according to the
Industrialists’ Union. Output in 2010 fell 1.4% to
201.3t, but the union has indicated that production
will recover this year to 205-207t, based on
increases in new projects.
Australia: The Australian Bureau of Agricultural
and Resources Economics (Abare) has forecast an
increase in domestic gold mine production of 14%
this year to 274t. Growth will be supported by the
ramping up of Newmont’s Boddington mine,
which, according to the Abare, may produce 25t
of gold this year. Several other new projects are
forecast to contribute to production. Abare’s
forecast for 2012 grows 3% to c282t. Several
midsize operations in Western Australia are
expected to boost domestic output. This new
output should more than offset declines from
some operations that nearing the ends their
lifespans.
Abare is optimistic about production in 2013 and
2014, which it expects to rise to 291t and 314t,
respectively. This is based on the projected start-
ups of large-scale projects in Queensland and the
Northern Territories. Production is expected to
flatten in 2015 and 2016 at 315t for each year, as
lower production from existing facilities offsets
increases from new projects.
China: China extended its position as the world’s
largest gold producer in 2010. According to the
China Gold Association, domestic gold
23
 Commodities
Global
10 May 2011
production increased 8.57% last year to a record
high of 340.88t. As discussed in our previous
editions of Precious Metals Outlook, China
appears unlikely to hold on to its top position in
the longer term. Although numerous, China’s gold
mines are small by international standards, and
they have relatively short lifespans.
The Chinese gold producing industry has gone
through a bout of government-sponsored
consolidation. China’s top 10 gold producers
accounted for nearly half of total output last year.
Meanwhile, the number of gold producers has
fallen to slightly more than 700 from 1,200 in
2009. According to the USGS, China has less than
two-thirds of the gold reserves of the US, despite
producing two-thirds more gold than the US in
2010. This implies that China does not have a
sufficiently large reserve base to sustain
production at current levels for the longer term.
The lack of well-defined reserves and the paucity
of world-class projects make it likely that Chinese
production will peak in 2012-13 and begin to
decrease thereafter.
Peru: Peru’s gold production in February fell
16.% from a year earlier to 12.5m grams,
according to the of energy and mining ministry.
The decrease was attributed to lower production
from some larger producers, including Minera
Barrick Misquichica, Minera Yanacocha, and
Compañía Minera Ares; their production fell 51%,
29%, and 20%, respectively, year-on-year,
according to the mining ministry. These declines
make it likely that 2011 output will come in below
2010 levels.
Official sector: The pendulum swings
After many years as heavy net sellers of gold, the
official sector has swung from an important
contributor to supply to a source of net demand.
Based on data from the Bank for International
Settlements and our own estimates, we believe
that the official sector in 2010 was a net buyer of
24
abc
gold for the first time in more than two decades,
absorbing c50t. This compares to net sales of
c30t, according to the Bank for International
Settlements (BIS).
According to BIS data, the signatories to the third
Central Bank Gold Agreement – once significant
sellers – sold only 7.1t in the first year of CBGA3,
which ended 26 September 2010. This did not
include the sale of a small amount of bullion for the
minting of gold coins. For the CBGA3’s second
year so far, the signatories have sold less than 1t.
This is a significant turnaround in policy from sales
patterns just a few years ago. Combined sales from
the first two CBGA agreements from 26 September
1999 to 26 September 2009 totaled 3,884t of gold,
or an average of 388.4t per year. This was more
gold than the annual output of South Africa, the
world’s largest gold miner at the time. The lack of
appetite for sales within the CBGA in the last two
years is an important bullish development for gold.
Under the rules of the agreement, the CBGA
signatories have a sales quota of 500t annually.
Given the paucity of sales to date and statements
by the two largest holders of bullion in the
CBGA, Germany’s Bundesbank and the Swiss
National Bank, that they have no intentions to sell
any more gold, it is unlikely that the signatories
will collectively sell anything more than a very
moderate amount of gold this year.
Although official sector sales were already
slowing ahead of the global financial crisis, we
believe that its onslaught – and gold’s strong price
performance during that period – led reserve
managers to reassess their gold sales intentions.
We see little likelihood that the signatories of the
CBGA will resume any level of meaningful sales
in the foreseeable future. Other large official-
sector holders of gold, including the US and
Japan, also have said that gold sales are off-limits.
 Commodities
Global
10 May 2011
The International Monetary Fund replaced central
banks as the main supplier of official sector gold in
2010. The IMF executive board approved sales of
gold that the IMF had acquired following the second
amendment of its articles of agreement in April
1978. This amounted to 403.3t, about one-eighth of
the IMF’s total holdings at the time of approval.
In November 2009, the IMF sold 200t to the
Reserve Bank of India, followed by 2t and 10t to
the central banks of Mauritius and Sri Lanka,
respectively. The IMF announced in February 2010
that phased sales of gold on the market would be
initiated to dispose of the remaining 191.3t. If
another official-sector buyer could not be found,
the gold would be sold on the open market through
the CBGA. On 7 September 2010, the IMF sold 10t
to the Bangladesh Bank. This reduced the amount
of gold that needed to be placed on the market. In
December 2010, the IMF concluded the gold sales
program, with total sales of 403.3t. The IMF has no
further plans to sell gold.
With no further sales forthcoming from the IMF
and the likelihood of only moderate sales from the
CBGA, any significant purchases of gold by
central banks would result in net purchases of
bullion by the official sector.
Outside the CBGA, the main purchases reported
in 2010 were from Russia. According to BIS data,
the Russian central bank purchased 139.8t of gold.
A handful of other countries, including the
Philippines, Venezuela, and Thailand, also
accumulated gold. China may also have
accumulated gold from domestic sources, but this
has not been reported to the BIS. In early May,
data from the Mexican central bank showed its
purchase of 3moz of gold in Q1 as part of its
foreign exchange reserves.
abc
With the exception of the Mexican purchase,
official data show little official-sector activity so
far this year. We consider it likely that the data
have not yet caught up with some of the
transactions. Emerging-market central banks are
likely to increase gold holdings, both as a means
to diversify away from the USD and as an overall
strategy of portfolio diversification, we believe.
The continuing rapid accumulation of USDs in
their foreign exchange reserves by many
emerging-market central banks may accelerate
this process.
We believe that central banks around the world are
adopting an increasingly favorable attitude to gold
and may therefore absorb a significant amount of
bullion this year from the international markets.
The Chinese monetary authorities will likely refrain
from making any direct international gold
purchases for fear of dislocating the market, in our
view. Rather, we believe, China will quietly
accumulate gold from domestic production, which
the central bank is not obliged to report to the BIS.
The rapid growth in foreign exchange reserves,
mostly in US dollars in emerging nations, implies
that central banks will have to buy gold if they
wish to maintain their current balance of gold to
foreign exchange holdings. In the absence of any
major sellers, we estimate that the official sector
could absorb net 300t of gold this year.
Scrap: A major source of supply
The absence of official sector sales leaves the
scrap market as the most important source of
secondary gold supply. Scrap supplies have
tended to rise in tandem with gold prices. The
scrap market grew from c600t in 2000 to c1,653t
in 2010, according to data compiled for the World
Gold Council by the GFMS precious metals
consultancy.
25
 Commodities
Global
10 May 2011
Although the bulk of recycled gold traditionally
comes from the emerging world, supplies from
the OECD nations have risen as a proportion of
market share in the last few years. According to
data compiled by GFMS for the World Gold
Council, scrap supply in 2010 was c20t below the
2009 level of 1,672t. Thus, scrap supply was
largely unchanged, despite a 29% increase in the
average price of gold in to USD1,225/oz from
USD973/oz in 2009. This argues against the
notion that scrap supplies are purely a function of
the gold price.
A modest improvement in employment in much
of the OECD world may be limiting distress scrap
sales. More important in the midst of still-high
gold prices, merchants and other scrap market
participants may be holding on to material in the
hope of resurgent prices. This may explain why in
the face of high prices, the market was not
deluged with additional scrap supplies.
The scrap market traditionally performs an
important function as a balancing mechanism in
the physical markets. Merchants typically
mobilize bullion stocks during periods of
escalating prices, thereby increasing supply, and
they reduce scrap supplies when prices are low.
We credit the appearance of substantial amounts
of scrap in 2008, 2009, and 2010 with helping to
supply bullion to the growing investment markets,
notably the ETFs. Without the contribution of
scrap, the physical markets would be in a
significant deficit, according to our
supply/demand model.
High prices eventually will stimulate additional
supply, in our view. Also, while merchants may
have been holding supply back from the market as
prices rose, the recent correction may trigger a
flood of scrap as holders rush to secure still-high
prices. We forecast scrap supply this year at
c1,650t, similar to the level in 2010. This
represents a c350t increase in scrap volume from
26
abc
our previous estimate of 1,300t for 2011.
Additional scrap supplies are likely to play a role
in tempering the rally, in our view.
Gold demand: Back from the brink
Dehedging: The final act
A long-running feature of the gold market has
been the industry trend toward dehedging, the
process whereby producers buy back or otherwise
close out previously established hedges.
Producers’ reversal in hedging policies dates back
to the beginning of the current bull cycle in 2001-
02. The pace of producer buybacks is slowing
markedly as a greatly diminished global hedge
book leaves producers with little in the way of
hedge positions to close out.
According to the Fortis subsidiary Virtual Metals’
“Gold Hedging Report,” the global hedge book in
Q4 2010 declined 1.7moz to 4.7moz from the
year-earlier quarter. For the entire year, the global
hedge book fell from 8moz to 4.7moz, a drop of
nearly 40% from 2009. The decline would have
been greater had it not been for the initiation of a
significant hedge by the Mexican miner Minera
Frisco that was initiated toward the end of 2010
but that was not reported until early this year.
Anglogold Ashanti reported in October 2010 that
it had eliminated the remainder of its hedge book,
which stood at 2.4moz. Other smaller hedges were
also wound down by other producers.
The global hedge book is unlikely to be
eliminated entirely. Gold hedges in 2010
increased for the second year in a row, albeit
moderately. It may be too early to herald a change
in producer attitudes toward hedging. But with
prices well above marginal costs and some new
projects requiring some form of hedging to attain
project financing, we may see a small recovery in
hedging going forward.
 Commodities
Global
10 May 2011
As producer dehedging slowly fades, an important
source of demand is gradually being removed from
the market. To this extent, reduced dehedging is
gold-bearish. Despite the initiation of some new
hedges in 2010, the industry remains collectively
bullish, and most mining companies continue to
embrace an antihedging philosophy. Consequently,
we expect new hedges to be modest. Dehedging
will inevitably be a dwindling source of demand, we
believe, simply because at less than 5moz, there is
little left in the way of hedges outstanding to close
out. After contributing c116t of new demand in
2010 and given the small size of the hedges
outstanding, dehedging will contribute just c25t to
demand this year, we expect.
Fabrication demand recovering
Jewelry consumption historically accounts for the
bulk of gold fabrication and is therefore the single
most important determinant of physical demand.
Jewelry’s share of total gold demand, however, fell
to c55% in 2010 from c75% in 2005. Jewelry
demand fell sharply in 2009 as the global economic
crisis and higher gold prices cut into consumer
demand. Led by emerging-market demand, jewelry
consumption recovered last year. Despite the
recovery, it will likely be several more years before
demand reaches pre-crisis levels, we believe.
According to data collected by GFMS for the
World Gold Council, jewelry demand in 2010
rose to c2,060t from c1,760t in 2009. The increase
was due in large part to a strong recovery in
emerging-market demand. Indian demand rose to
746t, an all-time high, from a multiyear low of
442t in 2009. The bulk of India’s gold jewelry
purchases occur in the northern tribal belt, a
predominantly rural region. A good monsoon and
high grain prices boosted rural income and
supported jewelry consumption. Demand also was
supported by Indian consumers’ optimistic
outlook regarding future price appreciation.
abc
Gold jewelry demand (t)
3500
3000
2500
2000
1500
1000
500
0
2001 2003 2005 2007 2009 2011f
Source: GFMS, WGC, HSBC
Chinese jewelry demand increased to c400t in
2010 from 352t in 2009, supported by gains in
inflation-adjusted consumer incomes and more
retail outlets for gold products. Other emerging-
market nations also increased their demand for
gold jewelry. The surge in demand across Asia
was supported by rising income, commodity
inflation, and USD weakness. This implies that
emerging-market buyers view jewelry as a form
of investment in addition to a luxury good.
A feature of the gold jewelry market over much of
the previous decade is the shift in the locus of
demand from the less price-sensitive Western
markets to the more price-sensitive emerging
markets. The majority of the world’s gold jewelry is
purchased in relatively price-sensitive areas of the
world, notably India, China, and the Middle East. In
most years, high prices curb jewelry demand, and
low prices stimulate demand. Last year was a
notable exception to this rule: Jewelry demand rose
in 2010 in the face of a virulent price rally. Rather
than a change in market dynamic, we believe, this
can largely be explained by the comparison with
weak demand in the previous year.
Logically, there is a limit to how much gold
jewelry consumers are willing to buy in the face
of rising prices. Although emerging-market
demand has been strong until now, we sense a
reluctance to increase purchases of more than
27
 Commodities
Global
10 May 2011
USD1,500/oz. Even accounting for the recent
pullback, current prices still make it difficult for
consumers to increase demand, even if their
disposable incomes rise.
While inflation may encourage gold purchases for
investment, jewelry must compete with necessary
expenditures, including foodstuffs and fuel,
staples that account for the bulk of consumer
budgets in emerging economies. High food and
fuel prices, examined earlier in this report, may
curb discretionary spending on jewelry. Similarly,
the patchy economic recovery in the US and
economic uncertainty in much of the OECD world
also might limit demand for gold jewelry. The
disaster in Japan is already curbing expenditures
on luxury items, including gold jewelry.
Global demand for gold jewelry will be largely
determined by consumption patterns in the
world’s two biggest gold markets: India and
China. Combined, they accounted for c60% of
global demand for gold jewelry in 2010. Demand
in these nations will be a trade-off between rising
incomes and inflationary concerns that should
support gold jewelry off-take, and high gold
prices and rising prices for food and fuel, which
could reduce consumers’ discretionary spending
on jewelry. Continued liberalization of the retail
gold segment in China should support jewelry
consumption. In the Middle East, high oil prices
should increase consumer incomes and bolster
jewelry demand in this important gold market.
Growth in demand for jewelry appears slightly
positive so far this year. Sales reports from
jewelry retailers in the US, Britain, Italy, Russia,
Japan, and Germany indicate that demand grew in
the early part of this year. Our views are based on
HSBC’s macroeconomic forecasts of global
economic indicators that are likely to impact
jewelry sales, including GDP growth,
unemployment, retail sales, and consumer
spending. While we believe that jewelry
28
abc
consumption will continue to make a limited
comeback this year, we believe gold prices above
USD1,500/oz are a threat to further sales growth.
Another spike in gold prices could erode jewelry
demand further, while a drop to closer to
USD1,200/oz could stimulate jewelry demand.
Because prices remain high despite the recent
correction, we do not expect jewelry off-take this
year to be greater than 2,100t, which would be a
c40t increase from 2010. This still would leave
gold jewelry consumption well below the peak
demand year of 2001, when off-take reached
c3,200t. Further price rallies have the potential to
depress jewelry demand to levels below those in
2010, especially in the emerging world. Indian
demand could be vulnerable if this year’s
monsoon season is poor and agricultural incomes
decline. See the chart on gold jewelry demand on
the previous page.
The decline in gold jewelry consumption during
the financial crisis freed up significant bullion
supplies, which, instead of being processed into
jewelry, went directly into the investment
segment. Without this shortfall in demand from
the jewelry segment, we believe the pace of
investor demand would have driven gold prices
even higher than current record levels. Were
investment to drop and gold prices to fall to levels
near USD1,200/oz, we would expect a
commensurate increase in jewelry demand. If
prices stay above USD1,500/oz, demand may be
constrained. However, if demand is more resistant
to high prices than we believe, then the
combination of persistently strong investment
demand and a resilient jewelry market has the
potential to drive gold prices higher.
 Commodities
Global abc
10 May 2011

Gold: Supply/demand balance (tonnes)

2003 2004 2005 2006 2007 2008 2009 2010 2011e
Mine production 2,593 2,463 2,522 2473 2,478 2,410 2,584 2,659 2,750
Official sector net sales 617 474 659 352 484 232 30 -50 -300
Old gold scrap 939 829 888 1,104 937 1,316 1,673 1,653 1,650
Producer hedging -279 -427 -86 -373 -400 -352 -254 -116 -25
Total supply 3,870 3,339 3,986 3,557 3,469 3,605 4,024 4,146 4,075

Jewelry 2,481 2,610 2,709 2,279 2,402 2,193 1,759 2,060 2,100
Electronics 235 261 281 304 316 293 246 287 300
Dentistry 67 68 62 61 59 56 53 50 50
Other industrial uses 80 83 85 86 87 91 74 83 85
Other fabrication 382 412 428 451 462 440 373 420 435
Total fabrications 2,863 3,022 3,137 2,730 2,864 2,633 2,132 2,480 2,535

Bar hoarding 178 245 262 226 257 386 216 380 340
Official coins 105 114 112 129 124 187 231 205 190
Metals 27 29 337 59 73 70 57 77 70
Other retail 15 -39 -24 -24 -32 215 227 333 270
Exchange-traded funds 32 119 208 250 211 321 617 302 230
Total investment demand 357 477 595 659 633 1,179 1,348 1,297 1,100

Total demand 3,220 3,399 3,732 3,380 3,3533 3,5811 3,480 3,777 3,635

Balance = net investment 650 -180 251 149 -28 -207 544 369 440

Gold price (USD/oz) 364 410 445 604 695 872 972 1,225 1,525
Source: HSBC, WGC, GFMS

29
 Commodities
Global abc
10 May 2011

Silver
 We expect the silver surplus to narrow this year; physical market
should be characterized by surging mine output and rebounding
industrial demand
 Investor demand for silver should recover from recent steep price
declines based on investor concerns about accommodative
monetary policies and heavy deficit spending
 We are raising our average silver price forecasts and introducing
an estimate for 2013

Lifting our silver price forecasts For 2013, we are introducing an average price
forecast of USD24/oz.
Our supply/demand model indicates that the silver
market will be in surplus by 43moz this year; Back to earth
narrowing from 178moz in 2010. We are raising
Based purely on the underlying physical
our average silver price forecasts for:
fundamentals alone, the silver story did not merit
 2011 to USD34/oz from USD26/oz. prices in the vicinity of USD50/oz reached in late
April, in our view. The subsequent steep
 2012 to USD29/oz from USD20/oz.
retracement to USD34/oz by the end of the first
 The long term (five years) to USD20/oz week of May is a more accurate reflection of
from USD15/oz. underlying fundamentals, we believe. According

Silver price (USD/oz) Silver trades directionally with gold (USD/oz)

60 50 1600
USD/o USD/o
45 1400
50 40
1200
35
40
30 1000
30 25 800
20 600
20
15
400
10 10
5 200
0
0 0
Apr-01

Apr-02

Apr-03

Apr-04

Apr-05

Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11

Oct-01

Oct-02

Oct-03

Oct-04

Oct-05

Oct-06

Oct-07

Oct-08

Oct-09

Oct-10
Apr-01

Apr-02

Apr-03

Apr-04

Apr-05

Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11

Silver 100 dMA 200 dMA Gold (RHS) Silver (LHS)

Source: Reuters Source: Reuters

30
 Commodities
Global abc
10 May 2011

to our supply/demand model, the market is in above cUSD40/oz or even higher in the near term,
surplus. Silver mine supply will grow, based on but that such levels cannot be sustained over the
production schedules and the increase in base course of this year. Therefore, we believe prices
metals from which silver is derived as a may ease further in the second half.
byproduct. Other sources of silver supply, notably
Recovery phase
scrap, will react to high prices and contribute to
supply. A revival in hedging policies by some Propelled by robust investor demand, silver prices
mines will contribute further to supply. almost doubled since touching a year-to-date low
of USD26/oz on 28 January. By the end of April,
Industrial demand for silver will continue to
prices had moved within striking distance of the
strengthen, we believe, based on HSBC
record high of USD50/oz set in January 1980.
macroeconomic forecasts of global industrial
production. This will be offset by increased mine The market had been on an almost unbroken
output and scrap supplies. Jewelry demand might upward trajectory since August 2010, when prices
not be able to rise much, due to high prices. broke above USD18/oz. The surge in prices was
accompanied by almost unprecedented investor
The driver of silver prices, we believe, will be
interest and continuing strength in industrial
investor sentiment. Until recently, investor demand
demand. The rally accelerated in the past couple
was able to absorb the excess physical silver
of months, as the eruption of popular discontent in
generated by rising mine output and the decline in
the Middle East and higher oil and other
industrial demand. Investor sentiment changed
commodity prices drove investors to seek out hard
abruptly in early May, when a drop in exchange-
assets, including silver. The re-emergence of
traded funds’ (ETF) silver holdings played an
sovereign risk concerns in the peripheral
important role in driving prices lower. Going
economies of the European Union and Standard &
forward, the role played by the silver ETFs and
Poor’s lowering of its long term credit outlook for
Comex will be crucial in determining price. If
the US spurred even greater buying in silver
investment demand were to falter further,
throughout March and April. Prices pulled back
substantial amounts of silver would move rapidly
sharply in early May as the Chicago Mercantile
onto the market, and silver supply/demand balances
Exchange raised margins for Comex silver
would record a greater surplus than we currently
investors. Prices fell to USD34/oz in the first
calculate. This leaves silver highly vulnerable to
week of May, a decline of c33% from the recent
changes in investor sentiment, in our view.
high near USD50/oz.
We believe investor concerns about the potential
The silver/gold ratio
inflationary impact of the US Federal Reserve’s
In the course of its rally, silver outperformed all
quantitative easing (QE) program, fiscal profligacy,
other major asset classes and most other
and geopolitical tensions will keep investors
commodities, including its sister metal, gold. This
interested in silver. The recent correction in prices
is evidenced by the fall in the silver/gold ratio to
also may boost what has heretofore been a
multiyear lows near 30:1 at the end of April 2011.
mainstay of the rally, strong demand for bars and
For most of the past 20 years, it has tended to
coins. Also, price-sensitive emerging-market
revolve at around 70:1. At the end of April 2010,
demand may increase, now that prices are back in
it stood at 68:1. The ratio had not been that low
the mid-USD30s/oz area. We believe that the
since the early 1980s, when it was rising after
market has enough momentum to push prices back
hitting its post-Bretton Woods low of 17:1 in

31
 Commodities
Global abc
10 May 2011

January 1980. The Bretton Woods system for Silver ETF demand (moz)

monetary and exchange rate management was 140

created in 1944, when gold became freely traded. 120
From this perspective, silver arguably became 100
expensive relative to gold. The recent correction 80
in silver prices has lifted the ratio to 42:1. This is 60
closer to its long-term historical norm. Over the 40
rest of this year, the ratio may move back to 50:1, 20
we believe. 0
2006 2007 2008 2009 2010 2011f
We find it interesting that even at its high this
year, silver remained far below its all-time high, Source: Reuters

set in 1980, of USD50/oz in real terms. In

inflation-adjusted terms the 1980 high was
equivalent to cUSD125/oz. From a historical
perspective, therefore, there is precedent for silver
to trade considerably higher now.
The surge in silver prices earlier this year was due
primarily to a sharp increase in investor demand,
rather than a compelling change in the underlying
supply/demand balances, in our view. The
significant rise in silver prices, which began at the
end of August 2010, coincided with the US
Federal Reserve’s signal at the time that it was
debating whether to reintroduce quantitative
easing. Concerns about the inflationary
consequences of the second round, QE2, and other
highly accommodative monetary policies,
combined with increased sovereign risks and
elevated geopolitical risk, triggered renewed
demand for hard assets, particularly the precious
metals, including silver. The Fed’s announcement
that QE2 would end in June 2011 did not
noticeably dim the silver rally. The nearby chart
shows the silver/gold ratio, with silver gaining on
gold until the silver correction in early May.
Along with gold and the other precious metals,
silver has been one of the few beneficiaries of the
recent economic crisis. Silver prices were trading
in a USD12-13/oz range in the weeks before the
eruption of the subprime mortgage crisis in May
2007. With silver benefiting from its safe-haven
status, prices have climbed c300% in almost three
years. Price corrections, when they occurred, have
tended to be brief but sharp.
A restoration of normal economic growth patterns
would likely end the silver rally, we believe,
especially if it were accompanied by tighter US
monetary policies and progress was made on
limiting deficit spending in the member states of
the Organization for Economic Cooperation and
Development (OECD). According to HSBC
macroeconomics, there are few indications that the
US economy is about to return to normal growth
patterns. As long as investors in and outside the US
remain uncertain about the US economy and
concerned about the possibility of QE-related
inflation and the implications of deficit spending,
we believe silver is likely to be well-bid.
Investor sentiment will remain the key
determinant of prices going forward, we believe.
Silver/gold ratio
75
70
65
60
55
50
45
40
35
30
Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11
Source: Bloomberg

32
 Commodities
Global abc
10 May 2011

Investor demand has absorbed the excess physical one-week drop since investors liquidated almost
silver generated by rising mine output. The silver c82moz in the week of 6 March 2007.
ETFs have absorbed sizable amounts of bullion in
Although some long positions have been
just a couple of years, holding the equivalent of
migrating from the Comex to the ETFs, should
c60% of annual silver mine output, more than
Comex liquidation continue at the pace of late
twice annual jewelry and silverware demand, and
April, further considerable downward price
based on our forecast of industrial and decorative
pressure may materialize in keeping with other
demand for this year, about c80% of that
periods of heavy liquidation by investors. We
segment’s annual consumption.
believe the reduction in price will encourage
The chart at the bottom-left of the following page further investor demand, and we are doubling our
shows investor positions on the Comex and the estimate of silver ETF accumulation this year by
silver price. Comex positions appear responsive to 40moz to c80moz, though this still would be less
prices, with long positions generally building on than the increase of 84moz in 2010.
rallies and contracting on downswings. The chart
If ETF investors continue to liquidate at the pace
at bottom-right overleaf combines Comex silver
seen in late April, sizable amounts of silver could
and ETF positions. The red section shows the
continue to appear on the physical market on short
growth in ETF off-take. Demand for ETF
notice, with a commensurate impact on prices. It
products has been fairly static, compared to the
may not even be necessary to liquidate ETF
beginning of the year, while long positions on the
holdings to have a negative impact on prices. The
Comex have been more volatile. The combined
market has become accustomed to substantial
holdings of all three silver ETFs – the Barclays
ETF demand, and should ETF demand merely
iShares and the smaller ETF Securities and the
flatten, the market would move into a more
Zurich Kantonalbank Bank (ZKB) – decreased by
substantial surplus, according to our
c7.5moz this year to 451t from 458.6t at the
supply/demand model. So far, however, silver
beginning of the year.
ETF investors have shown only a modest
Net long speculative positions on the Comex, inclination to liquidate, and most remain steadfast
while relatively high, are below record levels. Net even in the face of substantial price volatility.
long positions reached 330moz at the end of
Silver consumption for industrial and
October 2009, about 49moz below the peak of
manufacturing applications soared in 2010 and
378.9moz reached in February 2008. Long
remains robust this year. This is in line with the
liquidation drove net long positions lower in late
recovery in industrial production in the emerging
2009 and early 2010, bottoming out at 189moz in
markets followed by the OECD economies. Silver
early February 2010. Positions rebuilt by
is used in a wide range of industrial processes and
September 2010 to 327mozm just 3moz short of
applications, many of which are rapidly
the high for 2009, but fell to 251.7moz as of 25
expanding. These include the electrical and
January 2011. Net long speculative demand
electronic industries, notably batteries, catalysts,
surged in the following weeks to a high of
bearings, wiring, brazing, and soldering.
282.3moz as of 5 April. Comex positions have
since been subject to net liquidation, falling to Nonindustrial demand, specifically jewelry, is up
212moz as of 3 May. This included a 50.7moz only moderately from last year, we believe, but
drop between 19 April and 26 April, the sharpest photographic demand remains weak. The surge in

33
 Commodities
Global abc
10 May 2011

oil prices has led to an increase in demand for With prices far exceeding the cost of production
solar panels, which require silver. New by several multiples, producers have enormous
applications for silver in the biomedical, financial incentives to increase production.
environmental, and chemical industries will buoy Company reports by most primary silver
physical demand this year, in our view. producers put the vast majority of their production
costs at USD5-8/oz. Some higher-cost production
According to our supply/demand model, silver
is closer to USD10/oz, with the highest-cost
mine supply will continue growing at a healthy
projects that we are aware of not much beyond
pace for at least the next two years, due primarily
USD12/oz. Cost pressures may be rising,
to an increase in primary silver mine output and
however. Although prices have been well-
increases in mine byproduct output. Heavy
contained in the past couple of years, recent
investments made earlier in the mining cycle are
increases for essential inputs, notably steel cement
increasing primary silver mine production,
and diesel, as well as power, may pressure overall
notably in Latin America. High prices of silver
costs higher. Despite these increases, we do not
and base metals also provide miners with
anticipate that costs will rise anywhere
incentives to increase output wherever possible.
approaching a level at which they would
Costs of production are very low and are no
discourage production.
deterrent to production.
Furthermore, the majority of the world’s silver is
Supply trends
mined at low or almost no costs. More than two-
New generation of output at low cost thirds of silver production is a byproduct of base
In the 2011 Silver Survey prepared for the Silver metals and gold output, which implies that the
Institute, Gold Fields Mineral Services estimated marginal cost of production at these facilities is
that silver mine production totaled 736moz in close to zero. Thus, silver production is more a
2010, up more than 17moz from 2009. Silver function of base-metals output than of the silver
mine output has been rising steadily for several price, and it has therefore benefited from
years, supported by heavy investment earlier in increased production of gold and base metals. The
the mining cycle. Also, the rise in prices has made high price of base metals also gives base-metals
it easier for silver projects to receive producers considerable financial incentive to
financing and obtain additional funds to increase their output.
accelerate production.

Silver: Silver price and total speculative positions Silver: ETF and speculative interest
500 50 800 US 50
450 moz USD 45 700 moz
400 / 40 600 40
350 35 500 30
300 30 400
250 25 300 20
200 20 200 10
150 15 100
100 10 0 0
Oct-05

Oct-06

Oct-07

Oct-08

Oct-09

Oct-10
Apr-05

Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11

50 5
0 0
Oct-05

Oct-06

Oct-07

Oct-08

Oct-09

Oct-10
Apr-05

Apr-06

Apr-07

Apr-08

Apr-09

Apr-10

Apr-11

Net Spec Position (Moz) Silver in ETF

Silver price
Net Spec Position (Moz)
Sil i
Source: HSBC, Reuters, CFTC Source: HSBC, Reuters, CFTC

34
 Commodities
Global abc
10 May 2011

Silver mine supply (moz) offset by output declines at mature mines, notably
900 Silver Mine Production (Moz)
in Australia, Chile, and Canada. We anticipate
800 gains in output will far outweigh declines. Based
700
on the most recent company data and investments
600
made earlier in the mining cycle, we are raising
500
400 our forecast of silver mine output for this year by
300 at least 30moz to c765moz; we previously
200 forecast c755moz. Furthermore, we expect
100
production to continue to climb in 2012 by a
0
2001 2003 2005 2007 2009 2011f similar magnitude, based on company projections.
The nearby chart shows mine output.
Source: GFMS, Silver Institute, HSBC

Other sources of supply: What’s

Silver production has therefore also benefited coming down the line?
from the search for and development of gold and
Until last year, government sales of silver were a
base metals deposits. Development of base-metal
gradually diminishing source of supply. In 2010
discoveries that contain byproduct silver will
government sales jumped to c44moz from
continue to account for a significant share of
c15moz in 2009. Russia accounted for almost all
future silver reserves and resources. According to
of these sales. We attribute the increase in sales to
outlooks by base-metals consultants, such as the
the Russian government’s desire to take
International Copper Study Group and the
advantage of high prices. It is possible that high
International Lead-Zinc Association, as well as
prices may encourage further government sales
company forecasts, base-metals production is
this year, but we believe these will not exceed
likely to grow this year and next year. This will
20moz. Sales have also traditionally come from
support increases in silver production, especially
India, but we believe that if any government sales
as some of the new polymetallic mines have high
from this source appear, they will be quickly
silver byproduct content.
absorbed by the domestic market.
Thus, the bulk of mines will continue to produce
Scrap’s changing complexion
silver, virtually irrespective of price. Silver also is
Recycled silver is the second-largest source of
an exception to the rule that in the long term, the
silver supply after mine production. The largest
price of a commodity will tend to move toward
contributor to silver scrap recycling is the
the cost of the marginal producer. This explains
photographic segment. We have discussed in
why the bulk of silver production has been
previous editions of our Precious Metals Outlook
historically insensitive to price changes.
the long-running decline in silver scrap due to the
The majority of the world’s silver production shift to digital cameras from traditional
comes from Latin America, notably Mexico, Peru, photography. This trend shows no signs of
and Bolivia, and we expect this region will reversing. Eastman Kodak, Konica Minolta, Sony,
increasingly dominate global silver output. and Fuji Film report similar declines in traditional
Several projects in Russia and increased film sales due to the increasing popularity of
production at certain mines in North America and digital imaging technologies.
Africa also will contribute to strong increases in
output this year. Production gains will be partly

35
 Commodities
Global
10 May 2011
The most recent sales data from large filmmakers
confirmed that sales of silver nitrate-based film
continues to decline. In the Silver Survey, GFMS
estimated 2010 photographic demand at 72.7moz,
a decline of 6.6moz from 79.3moz in 2009. We
believe that demand in this category will ease to
c70moz this year.
We anticipate lower silver consumption by the
photographic industry and commensurately lower
recycled silver rates for this and next year.
Other components of the scrap market look set to
grow. Although the industrial segment is by far the
largest consumer of silver, it accounts for a far
smaller proportion of silver scrap supply. This may
be because silver is generally used only in small
quantities in most industrial and manufacturing
applications. This made it uneconomical to recycle
at prices below USD20/oz. The surge in prices is
changing the calculus of the industrial scrap
market. At prices above USD30/oz, we believe,
industrial users have sufficient reason to seek to
recycle considerably more scrap this year than in
previous years.
In addition to the price incentive, environmental
legislation initiated in 2009 now requires
recycling of a wide variety of electronic products
with a silver component, such as cell phones and
calculators. This could be a significant
development, as about two-thirds of industrial
silver demand is for electrical and electronic
goods, including PCs, cell phones, and other
telecommunications devices. How much more
scrap from this segment will materialize is
difficult to judge, but even if prices retreat
substantially, we believe there will be sufficient
economic incentive to increase recycling rates.
36
abc
The recycled silver jewelry market has not been a
major source of supply, unlike gold, where it is an
important source of supply. This may be because
the silver supply appears to be far less price-
sensitive to recycling than that for gold, possibly
because of higher sales margins for silver
products. At current prices, we believe, this metric
also is changing. Higher prices are encouraging
the public to hand in more jewelry and other silver
items. Based on our conversations with smelters
and refiners, we believe that the public is selling
greater amounts of old silver items and jewelry
for recycling, often along with gold items. An
element of this may be distressed selling and more
due to high unemployment than the price of silver.
Also, high premiums on coin prices have virtually
wiped out the recycled coin market.
According to GFMS, scrap supply rose by a sharp
c27moz last year to 215moz. According to our
supply/demand model, scrap supply contributed
c9moz more to supply than new mine output. We
expect that scrap supply may increase c20moz in
2011, based on current high prices. Further
increases in scrap supply, along with increased mine
output, have the potential to curb the silver rally.
Hedging: New attitude at higher
altitude
Similar to gold producers, silver producers have
tended to close out or buy back hedges in recent
years. Because the bulk of silver output is
obtained as a byproduct of gold and base-metals
production, the marginal cost of producing the
majority of the world’s silver is low. The
incentive to hedge is therefore correspondingly
low. Prices well above the marginal costs of
production also reduce the need to hedge.
Traditionally, mining companies have displayed a
collective bias against hedging, and the industry
still embraces an antihedging philosophy.
 Commodities
Global
10 May 2011
That said, we detect a small change in attitude by
some producers. The rally earlier in the year may
have reached levels at which even reluctant
producers were willing at least to reexamine their
hedging strategies. We detected the initiation of
some new hedges toward the end of 2010.
According to the Silver Institute’s Survey
compiled by GFMS, producers hedged c61moz in
2010. This marked the first net hedging by the
industry since 2005. We anticipate that net
hedging may contribute c40moz to supply this
year. The sudden drop in prices may also
encourage producers to implement hedges. Should
silver prices drop further, it is possible that
producer hedging could exceed our forecasts as
producer rush to lock in prices.
Demand trends
Investors demand for silver coins and physical
silver bars was strong last year and remains
vigorous. Based on our conversations with
merchants and dealers, we believe that coin
demand will remain robust this year and will rival
but probably not exceed the record-high demand
year of 2010. According to the US and Royal
Canadian mints, silver coin sales remain strong
this year. In January, 6.42m of the 1 oz Silver
Eagle coins were sold. Although these sales eased
in February, March, and April, they remain
historically high. The recent pullback in prices
may stimulate more retail investor appetite for
silver coins. We forecast sales of coins and
medals will remain high at c90moz this year but
not exceed 2010 levels.
Coin and bar demand as a percentage of total
demand is growing but is still modest, compared
to jewelry and industrial uses. Nonetheless, we
believe that demand for these products accurately
reflects widespread retail investor concerns about
inflation and USD weakness, fiscal profligacy,
European sovereign debt risks, and geopolitical
tensions. These concerns are driving demand for
abc
hard assets, including silver. A prolonged drop in
sales may be an early signal that the price
correction is not over.
Fabrication: Industrial action
Industrial and decorative demand for silver soared
in 2010 from depressed levels in 2009, in line
with the recession and the global slide in
industrial production. As industrial production
recovered, demand for silver is robust in the
emerging and developed worlds. We forecast
substantial growth in industrial demand for silver
this year, based in part on HSBC economics
forecasts of growth in global industrial output of
6.4%, with 9.0% growth in the emerging markets
and 4.1% in the developed world. We forecast an
increase in demand of c65moz to c552moz. In
2010, demand grew c84moz to 487moz, following
a decline in 2009 of c89moz to 404moz,
according to data compiled for the Silver Survey
by Gold Fields Minerals Services.
The electronic and electrical segments account for
roughly two-thirds of industrial silver
consumption. Using semiconductor demand as a
rough proxy for electrical and electronic demand,
it appears that industrial silver demand is surging.
Semiconductor Industry Association (SIA)
President Brian Toohey has said that impressive
growth in a wide range of products reflects strong
demand for semiconductors. An important
component of growth was the automotive
industry, which was increasing its demand for
semiconductors. The world semiconductor market
grew 31.8% in 2010, according to the SIA’s
reporting of World Semiconductor Trade
Statistics data. The SIA forecasts 9% growth for
2011 and 10% for 2012.
New applications for silver hold the possibility of
increased demand in the medium to longer term. We
have outlined the potential for increased silver
demand from these areas in previous editions of our
Precious Metals Outlook. Two of the fastest-
37
 Commodities
Global abc
10 May 2011

growing new uses for silver are biomedical Silver: Industrial and decorative demand (moz)

applications and solar panels. The Silver Institute has 600

identified solar panels as holding significant 500
potential. Other new uses include green
400
technologies, security issues, food packaging, and
300
cleaner energy sources. On an individual basis, these
new applications for silver are small in comparison 200

to other sources, but collectively, we believe, they 100

will make a modest contribution to demand this year 0

2011f
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
and next year.

Jewelry demand Source: GFMS, Silver Institute, HSBC

Retailers reported a recovery in jewelry demand in

2010 and early 2011 from disappointing sales in
2009. Based on our conversations with merchants
and fabricators, we believe that demand for jewelry
and silverware has increased only moderately so far
this year. Silver also could be gaining some market
share at the expense of gold from price-sensitive
buyers. Had prices remained in the vicinity of
USD50/oz, we believe that jewelry demand may
have contracted this year. Lower prices should help
promote jewelry sales. This may be offset by
persistent economic uncertainty in the US and other
countries and declines in consumer sentiment, which
may discourage consumers from purchasing luxury
goods such as jewelry.
GFMS estimates that jewelry demand in 2010
totaled 167moz in 2010, up from 158.9moz in 2009.
Based on prices, we believe that jewelry demand
may edge down to c165moz in 2011. Silver demand
dropped to 50.3moz in 2010 from 58.2moz in 2009.
Based on high prices, we believe that silverware
demand will not exceed c50moz this year.
Indian demand, a major driver of jewelry demand,
continues to recover from a near-collapse in
imports in 2009. Heavy physical imports were
recorded in India in late 2010 and earlier this year.
Some of this may be due to a switch from more-
expensive gold to silver by price-sensitive
consumers. Based on our conversations with

Silver: Supply/demand balance (moz)

2003 2004 2005 2006 2007 2008 2009 2010 2011f
Mine production 597 613 637 641 664 685 718 736 765
Official sector sales 89 62 66 78 43 28 14 45 20
Old silver scrap 184 184 186 188 182 176 188 215 235
Hedging 0 10 28 0 0 0 0 61 40
Total supply 870 868 916 907 889 888 889 1,057 1,060

Fabrication
Industrial and decorative 351 368 407 427 456 443 352 487 552
Photography 193 179 160 142 125 105 83 73 70
Jewelry and silverware 263 242 241 227 222 215 216 217 215
Official coins 36 42 40 40 40 65 79 101 90
Total fabrication 842 831 848 836 843 828 729 879 927
Exchange traded funds 0 0 0 121 95 95 110 84 80
Hedging 21 0 0 7 24 12 22 0 0
Total demand 869 868 848 964 962 935 862 962 1,007

Market balance 1 0 68 -57 -73 -47 137 95 53

Market balance ex-govt stock sales -88 -62 -2 -135 -116 -75 13 50 33

Price (USD/oz) 4.88 6.66 7.31 11.55 11.55 14.99 14.99 20.19 34.00
Source: HSBC, Silver Institute, GFMS

38
 Commodities
Global abc
10 May 2011

merchants, we expect Indian demand to remain

robust. The price decline from USD50/oz could
stimulate further physical off-take. The bulk of
Indian silver demand is located in rural areas, and
the impact of the monsoon on the harvest and
agricultural incomes will remain a strong factor in
determining Indian silver demand. High food
prices in India have boosted rural incomes and
helped support silver demand.

39
 Commodities
Global abc
10 May 2011

Platinum
 Platinum is likely to remain in a modest deficit in 2011, as we
expect a mixed recovery in global auto production and strong
industrial demand; investor demand will play a pivotal role
 We estimate producer output will increase modestly this year,
assuming no major production disruptions in South Africa
 We are increasing our forecasts of average platinum prices and
introducing a forecast for 2013

Raising our platinum price
forecasts
We are raising our forecasts of average platinum
prices for:
 2011 to USD1,850/oz from USD1,750/oz.
 2012 to USD1,750/oz from USD1,650/oz.
 The long term (five years) to USD1,625/oz
from USD1,600/oz.
growth rate than in 2010. Auto demand increases,
the HSBC equity research analysts expect, will
come principally from North America and the
emerging world, notably China. Jewelry demand
may be constrained by high prices, we believe.
The decline in Chinese jewelry demand should
help narrow the supply/demand deficit that we
forecast for 2011. Should jewelry demand falter,
this could have a noticeable impact on our
supply/demand balance.

For 2013, we are introducing a forecast of On the supply side, higher prices are encouraging
USD1,650/oz. platinum production at the margin in South
Africa, but producers face a variety of challenges,
Heading moderately higher
Based on our supply/demand model, we expect Platinum price (USD/oz)
the platinum market to move from a surplus of 2,500
290,00oz in 2010 to a deficit of 30,000oz this 2,000
year. Although this deficit would be small, we 1,500
believe that it would be psychologically
1,000
significant and support prices.
500
On the demand side, increases in auto production 0
Apr-01
Apr-02
Apr-03
Apr-04
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apr-10
Apr-11

seem likely for the remainder of this year,

according to automotive analysts on HSBC’s
Platinum 100 dMA 200 dMA
equity research team, but at a more moderate
Source: Reuters

40
 Commodities
Global
10 May 2011
including a shortage of trained personnel and
equipment and the impact of a strong ZAR. Power
supplies remain tight, and should there be another
electricity outage such as the one in 2008, the
resulting decline in output could trigger a steep
price rally. Much also will depend on the number
of industrial stoppages and accident related
shutdowns this year. These occurrences have
clipped production noticeably in recent years.
Investor demand for platinum soared in 2010,
particularly for the US-based ETFs. Investment
will play a critical role in determining prices this
year, in our view. Demand into hard assets,
including platinum, is channeled by investor
unease about inflation, fiscal profligacy, and
volatility of financial markets. We expect investor
demand to cool in 2011 from the strong gains of
2010 but to remain positive as long as investors
remain uneasy about the global economy.
Driving moderately higher
Platinum prices have more than doubled since
bottoming out just below USD800/oz in
November 2008. Prices moved steadily higher
throughout 2009 in response to lower mine output
and increased demand from the recovery in global
auto production. The rally accelerated in 2010,
hitting USD1,752/oz on 2 May, before retracing
to USD1,452/oz on 21 May, as the sovereign debt
crisis triggered fears of a fresh global economic
slowdown. After trading in a broad, sideways
range for much of last summer, prices took off
again in September, as investor demand for hard
assets rose in response to the US Federal
Reserve’s announcement of a likely return to
quantitative easing. Prices climbed above
USD1,800/oz in mid-November before correcting
to USD1,693/oz by late November.
A positive outlook for industrial demand and
strength in other commodities, notably gold,
buoyed platinum, which reached a year-to-date
high of USD1,884/oz in early May, after
abc
recovering from a fierce but short-lived decline to
USD1,654/oz in mid-March. The decline was
triggered by the March earthquake and tsunami in
Japan, the suspension of a large part of Japanese
auto production, and concerns that automotive
demand for platinum would also decline. Prices
resumed their upward advance in April but fell
back again in early May in line with a decline in
gold and silver prices, though they remained well
above the March lows. Since then, opportunistic
buying by investors halted and then reversed the
slide. Platinum remains considerably below its all-
time high of USD2,300/oz set in March 2008.
The outlook for platinum prices remains generally
positive, in our view. Platinum mine output
growth is likely to be higher, but limited, and auto
recycling levels may decline from 2010, while
both auto and industrial demand are likely to
continue to grow.
We expect weaker platinum jewelry demand in
response to higher prices will free up additional
supply for the auto and industrial segments. We
anticipate a wide trading range for platinum of
USD1,300-1,950/oz this year.
Platinum market deficit in 2011e
Based on our supply/demand model, we expect
that the platinum market will remain in deficit,
narrowing slightly to 30,000oz this year from
40,000oz in 2010.
On the demand side, increases in auto production
are likely for the remainder of the year, HSBC
equity research analysts believe. US auto demand
is strong but that market is still recovering from
very low levels in 2008-09, and auto production in
the US remains substantially below 2000-08
averages. Chinese platinum demand for autos will
be crucial in determining price. Auto production
in China is slowing from very strong levels in
2010, but remains relatively robust. This holds
true for most emerging-market nations. European
41
 Commodities
Global
10 May 2011
auto production is also pushing higher at a
moderate pace. Based on automotive production
forecasts by HSBC equity research analysts, we
estimate only a moderate increase in automotive
demand for platinum in 2011.
Inevitably, high prices are curbing consumer
demand for platinum jewelry, despite its
attractiveness, notably to the key bridal market.
Also, food and fuel prices will crimp consumer
incomes and limit Chinese jewelry demand at the
margin. The decline in Chinese platinum jewelry
demand should help narrow our forecast of a
supply/demand deficit in 2011. Should Chinese
demand falter further, this could have a noticeable
impact on our supply/demand balance.
Investor demand for platinum soared in 2010,
particularly for the US-based ETFs. Investment will
play a critical role in determining prices this year, in
our view. Demand into hard assets, including
platinum, is channeled by investor unease about
inflation, fiscal profligacy, and volatility of the
financial markets. We expect investor demand to
cool in 2011 from the strong gains of 2010 but to
remain positive as long as investors remain uneasy
about the global economy.
On the supply side, higher platinum prices are
encouraging production at the margin in South
Africa, but producers face a variety of challenges,
including a shortage of trained personnel and
equipment and the impact of a strong ZAR. Power
supplies remain tight, and another electricity outage
occur, such as the one in 2008, the resulting decline
in output could trigger a steep platinum price rally.
Much also will depend on the number of industrial
stoppages and accident-related shutdowns this year.
These occurrences have clipped production
noticeably in recent years.
42
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Supply trends: Looking flat
Enough supply for decades …
We expect the platinum mine supply to continue
to increase as high prices – well above the costs of
production – provide a considerable financial
incentive to producers to increase output, despite
a host of challenges, including rising costs and
infrastructure challenges in South Africa that may
limit increases in output.
South Africa occupies a commanding position in
world platinum production and reserves, accounting
for 4.6m oz of output in 2010, or about three-fourths
of world mine output, according to Johnson
Matthey. The enormous deposits of platinum group
element (PGE) in the Bushveld Complex in South
Africa can be confidently relied upon to provide a
major proportion of global needs for many decades
to come, even if the appetite for platinum accelerates
well beyond current assumptions.
According to a report published at the end of last
year by R. Grant Cawthorne of the School of
Geosciences, University of the Witwatersrand,
c80% of the world’s PGE are in the Bushveld
Complex. The report cited an estimated that
Bushveld has sufficient PGE deposits to supply
world demand for many decades, even assuming
no advances in mining and extraction technology.
We found it interesting that the scope of the paper
went beyond the usual time frame of most
commercial geological studies, suggesting that
published reserve estimates are often restricted by
rigorous international reporting codes.
Nonetheless, even with the limitation of the
regulatory codes, the reserves and resources
reported by the four major mining companies in
South Africa amount to at least 1.2bnoz of PGE,
of which more than 50% is platinum, according to
Mr. Cawthorne.
 Commodities
Global
10 May 2011
… but constraints in South Africa
persist
Despite abundant platinum resources and high
prices, the platinum industry has been growing
well below private and government growth
forecasts, expanding just 4% per year since 1990.
South African producers face a host of challenges
to raising output, including rising costs, notably
for power, steel, cement, and diesel, high labor
costs, safety issues, a shortage of trained
personnel, long lead times to secure new
equipment, power shortages, increased
government regulation and supervision, and a
strong ZAR. The following chart shows South
African platinum production.
South Africa: Platinum production (moz)
5.4
5.2
5
4.8
4.6
4.4
4.2
4 in USDs. Thus, producers are affected by the
2003 2005 2007 2009 2011f
Source: Johnson Matthey, HSBC
We regard limited power supplies in South Africa
as one of the biggest threats to raising platinum
output in 2011 and beyond. Platinum mining is a
highly power-intensive enterprise, and platinum
group of metals (PGM) producers are reliant on
Eskom, the South African state-owned energy
utility, for the vast bulk of their power
requirements. Platinum production – and prices –
are extremely sensitive to even modest reductions
in power supplies. Eskom has acknowledged that
power supplies will remain stretched until
September 2012 at the earliest, when the first of
six units of the 4,800MW plants under
development are expected to come on stream.
abc
Supply constraints will not ease substantially until
2017, when additional power stations are slated to
come on line.
In the near term, Eskom faces the possibility of
labor disruptions as the peak winter demand period
approaches. Members of the National Union of
Mineworkers (NUM) employed at Eskom recently
reiterated that they would take strike action against
the state power utility in pursuit of a 16% wage
increase. An NUM spokesman has said that
although there was no time frame for the labor
action, it would likely be before midyear. The
NUM has said it has 16,000 employees at Eskom,
which has a total workforce of 40,000. Given tight
underlying supply/demand balances and the
paucity of above-ground stocks, we believe that
any disruption of power generation sufficient to
halt production, even briefly, could have a
pronounced impact on prices.
Cost pressures due to a strong ZAR are another
challenge with which producers have to cope. The
bulk of expenses, including power supplies and
labor, are priced in ZARs, while platinum is sold
USD/ZAR exchange rate. Historically, platinum
producers have often found themselves pressured
by either a low USD price for platinum or a strong
local currency. Should the ZAR continue to
strengthen against the USD, producers will come
under further cost pressure.
Miners are also faced with escalating costs of steel,
cement, fuel, and other inputs. Since 2009, platinum
prices have risen faster than input prices, and
producers have been able to cover their costs easily.
Thus, high prices may have constrained production
but they have not triggered cutbacks. Any sudden
drop in platinum prices to near USD1,250/oz could
jeopardize some high-cost projects.
43
 Commodities
Global
10 May 2011
Zimbabwe won’t make a dent soon
Zimbabwe has the world’s second-largest PGM
reserves after South Africa. The Great Dyke could
account for as much as 20% of known platinum
reserves and holds the largest platinum deposits in
the world after the Bushveld. The prospects for
supply increases outside South Africa are limited.
Theoretically, Zimbabwe presents producers with
almost ideal mining conditions. The workforce is
well-educated and technically proficient, and
platinum reserves are easily accessible, lying in
scalable formations near the surface. Costs are
lower than in South Africa, and working
conditions are relatively safe. In practice,
however, realizing Zimbabwe’s potential has been
slow going. Development of PGM resources has
been impeded by inadequate infrastructure,
hyperinflation, poor economic conditions, and
often ineffective government policies, according
to the Zimbabwean Chamber of Mines.
Perhaps the greatest threat to the long-term
development of Zimbabwe’s PGM segment is
government legislation, particularly the
Indigenization and Economic Empowerment Act,
which requires foreign-owned companies to cede
51% of their equity to indigenous people. We
discussed the law in more detail in Precious
Metals Outlook: Golden sovereign (risk), (May
2010). The mining industry in Zimbabwe could
stop growing if the government presses ahead
with forcing companies operating in the country
to be majority-owned by indigenous investors.
Earlier this year, Prime Minister Robert Mugabe
reiterated his determination to speed up the
process under which ownership is transferred to
indigenous peoples. Mr. Mugabe’s partners in the
coalition government, the Movement for
Democratic Change, oppose implementing the
law too quickly and are known to have a more
pro-mining bias than the Mr. Mugabe’s party.
How the implementation of the law plays out may
44
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have important consequences for long-term
platinum production.
The president of the Zimbabwe Chamber of Mines,
Victor Gapare, said recently that although the
mining industry is central to the country’s economic
recovery, inept government policies threaten its
viability. Mr. Gapare said that although investors
that are already committed to mining in Zimbabwe
would likely stay, the indigenization issue could cut
off new capital coming into the industry. He said the
mining industry needed an additional USD5bn of
investment, with much of that required by the PGM
segment, to meet its potential. Because Zimbabwe’s
domestic financing sources are insufficient, all of
this funding would have to come from abroad, he
said. Most investors are waiting for completion of
the indigenization and economic empowerment
provisions before they invest further in Zimbabwe,
according to Mr. Gapare.
Despite these impediments, Zimbabwe should
produce c1moz of platinum annually in the next 10-
15 years, according to Mr. Gapare. Earlier this
month, Anglo Platinum announced the opening of its
new USD600m Unki Mine, which the company’s
expects will become Zimbabwe’s second-largest
platinum producer. Anglo Platinum’s Zimplats
division announced last year an investment of
USD450m for its expansion program.
Despite production challenges, we expect South
African production will grow from 4.585moz in
2010 to 4.75moz this year. Outside South Africa,
we see moderate increases in output trends.
Johnson Matthey has estimated that Russian
platinum production rose to 810,000oz in 2010
from 785,000oz in 2009. We believe it will be
difficult for Russian production to total more than
820,000oz in 2011. We also see higher production
in Zimbabwe, despite uncertain economic
conditions in that country.
 Commodities
Global
10 May 2011
Challenges not bad enough, though
In response to high prices well above marginal
costs of production, producers are increasing
output wherever possible. They are expanding
output and increasing exploration and production
budgets. Despite these efforts, we expect mine
supply to be constrained by increasingly frequent
industrial stoppages and safety-related shutdowns.
The world’s largest platinum producer, Anglo
Platinum, announced recently that its 2011
production target of refining and selling 2.6moz
remains unchanged, despite a 5% fall in
production in Q1. For the first three months of
this year, Anglo posted output of 560,000oz. The
decline was attributed to safety-related stoppages.
The company said it had initiated plans to make
up for lost production. It said it experienced more
safety stoppages in Q1 this year than during all
of 2010.
Eastern Platinum has announced that production
at its Crocodile River mine in South Africa in Q1
fell by 7,365oz to 25,387oz from the previous
quarter. An interruption in production due to an
internal safety review carried out in January was
responsible for the drop in output, according to
the company.
Impala Platinum is South Africa’s second-largest
platinum producer. In February, the company
announced that its platinum sales for the six
months ended 31 December 2010 totaled
801,000oz, up 15% from 694,000oz a year earlier.
Unit costs were well-contained in the period, at
ZAR10,271 rising 4% on an annualized basis as a
result of the higher output. Meanwhile, capital
expenditures increased 11% to ZAR2.4bn. The
company said that a recovery at the giant
Rustenburg mine was on track and that Mimosa
continued to meet operational targets. The
company has said its expansion strategy at
Zimplats is making satisfactory progress. The
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company’s long-range production target of
2.1moz by 2014 is remains intact.
Lonmin, the world’s third-biggest platinum
producer, reported that for its fiscal first quarter
ended 31 December, refined platinum production
fell to 81,982oz from 110,786oz a year earlier.
The shortfall was due to the rebuilding of its main
furnace. The rebuild and modification of the No. 1
furnace were successfully completed on schedule,
and the furnace was recommissioned in mid-
December 2010.
Lonmin is targeting sales of 750,000oz of refined
platinum in the current fiscal year, up from
706,000oz a year earlier. It has a growth profile of
700-850,000oz total PGM. This should be
achieved, according to the company, by ramp-ups
at the Saffy, Hossy, K4, and K3 operations over
the next five to seven years.
Aquarius Platinum, the world’s fourth-biggest
platinum producer, said it had increased its
attributable production 14% in the three months
ended 31 December. Aquarius produced
127,579oz of PGMs in the quarter, a 14%
improvement on output from a year earlier and a
3% increase from September quarter production.
Aquarius CEO Stuart Murray said that production
was up strongly at the main Kroondal mine, and
that both Kroondal and Marikana managed to
reduce rand cash costs. Mr. Murray said the
reopened Everest mine remained on schedule and
continued to ramp up output. That mine was
closed in late 2008, owing to a subsidence event.
Aquarius remains on target to meet its production
guidance for fiscal 2011.
Norilsk Nickel, the world’s largest nickel and
palladium producer, is also the biggest producer
of platinum outside South Africa. Earlier this
year, Norilsk announced preliminary consolidated
production results for the fourth quarter and all of
2010. The company reported production of
45
 Commodities
Global abc
10 May 2011

161,000oz in Q4 and full-year output of
693,000oz. Production in 2010 rose 5% from
2009, driven by increased output at Norilsk’s
Russian operations.
For 2011, Norilsk plans to produce 665,000-
675,000oz at its Russian divisions and 40,000-
45,000oz at its international operations, a slight
increase from last year. As platinum is refined as
a byproduct, platinum production much will
depend largely on whether Norilsk meets its
nickel output targets.
These figures do not include output from
Stillwater Mining Co., a subsidiary of Norilsk.
Alluvial output from smaller Russian producers
appears to be unchanged or down very slightly.
Recycling: Less to get per car
The recycling of catalytic converters and
particulate filters is a significant source of
secondary platinum supply and is the second-
largest contributor to supply behind South African
production. We estimate that recycled platinum
from the automotive industry will amount to
c950,000oz in 2011, down from Johnson
Matthey’s estimate of 1.095m oz in 2010.
Platinum derived from auto recycling topped
1moz for the first time in 2010, despite the end of
incentive programs across the OECD countries in
2009 designed to encourage recycling of older
platinum-heavy vehicles. We believe that
recycling levels increased in part from the
recovery in global auto sales, which continued the
recycling trend of older vehicles. We expect
recovered platinum to drop even if the number
recycled autos rises. We expect that many of the
vehicles being traded in this year will have
lighter platinum loadings due to switching
and substitution than models made five to
10 years ago.
High platinum prices also are triggering an increase
in jewelry recycling rates. According to Johnson
Matthey, platinum from recycled jewelry hit a record
735,000oz in 2010, up 30% from 565,00oz in 2009.
Of the 2010 total, 450,000oz, or c60%, came from
China. Based on our conversations with smelters and
refiners, high prices are likely to encourage even
more recycling this year.
Demand trends
Recovery in auto demand expected
Platinum is a necessary component in the
production of autocatalyst and particulate filters.
The auto industry generally accounts for more
than half of global platinum consumption. Thus,
auto demand is an important if not critical driver
of physical demand for platinum. The worldwide
contraction in auto sales in 2H 2008 and 1H 2009
greatly reduced the amount of platinum required
by the auto industry, allowing jewelry temporarily
to reclaim its former position as platinum’s single
biggest source of demand. The near implosion in
auto demand also was the principal reason for
platinum’s slide to a multiyear a low of
USD732/oz by late October 2008. Platinum
demand from the auto industry plummeted to
2.185moz in 2009 from 3.655moz in 2009,
according to Johnson Matthey estimates, due to a
steep slide in auto production.
The global auto industry has staged a strong
recovery that began in late 2009 and stretched
through 2010. Demand last year demand bounced
back to 2.985moz on a continued recovery in auto
production. Demand in China, which replaced the
US as the world’s largest auto market in 2008,
was especially robust. Sales in other emerging
markets, including India, the Middle East, and
Latin America, were strong. Auto purchases in the
US recovered notably in 2010. The recovery in
auto demand in Europe was less pronounced than
that in most other OECD markets.

46
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Global abc
10 May 2011

World auto production appeared poised to slow in
2011 even before the disaster in Japan, according
to automotive analysts in HSBC equity research.
A less-positive global economic climate, rising
commodity prices, and the re-emergence of
sovereign debt concerns in OECD nations are all
contributing to a cooling of auto demand.
Emerging-world demand for autos is being hurt
by rising food and fuel prices, which are reducing
consumers’ disposable incomes, as well as by the
withdrawal of tax subsidies in China for new car
purchases. The effects of the earthquake and
tsunami in Japan have curtailed domestic auto
production, but as the year unfolds, other
producers will pick up much of the shortfall in
production, according to HSBC
automotive research.
Light-vehicle production forecasts by HSBC
equity research analysts Horst Schneider and
Niels Fehre forecast growth of 3.5% in global
auto and light-truck production this year to 76.7m
units. This is down from their previous forecast of
5% growth to 77.4m vehicles, revised in light of
the Japanese disaster.
We forecast a moderate increase in platinum
demand for this year of c4% to 3.11moz. This is
based on HSBC equity research estimates of
global light-truck and auto production, and the
disruption in output in Japan, continuing
substitution, and thrifting and PGM loadings, as
well as demand for heavy diesel vehicles. Auto
demand reflects the mixed performance of the
global economy. Following a sharp rebound in
2009-10 in most of the OECD world and robust
gains in the emerging world, the tempo of global
auto demand began to slow this year.
The main threat to auto demand is inflation,
according to HSBC equity research analysts. Oil
prices rises are discouraging purchases of large
vehicles, and steel, copper, plastics, and other
input price increases are making autos more
expensive. Furthermore, food price inflation is
forcing consumers in the emerging world to divert
spending to necessary staples and may limit
auto purchases.
With the major exception of Japan, where auto
demand has slumped in the wake of the
earthquake and tsunami, global auto demand
remains firm, though down from the strong levels
of 2010. On a regional basis, HSBC equity
research on the automotive industry expects
Japanese auto production in 2011 to decline
c10.1% this year from a year earlier. But the team
anticipates that output will grow 2.2% in Western
Europe, 10.1% in the US, 8.9% in China, and
4.5% in Asia excluding Japan and China.
Substitution continues. It is fair to say that the
recovery in the auto industry has favored
palladium over platinum consumption. While auto
sales for all vehicle types have risen across the
board since the slump in demand in 2008-09,
demand for gasoline-driven vehicles has
noticeably outstripped demand for diesel-powered
vehicles by a considerable margin. Gasoline-fired
vehicles have a much greater palladium weighting
than diesel vehicles and require relatively little
platinum. This largely explains why demand for
palladium for the automotive industry has been
more pronounced than that for platinum.
High prices continue to encourage auto companies
to continue to look for ways to substitute higher-
priced platinum for palladium or to reduce
platinum loadings outright. Auto makers’ funds
devoted to research on substitution and thrifting
were cut in 2008-09 but have since been restored.
Based on our conversations with auto executives,
we believe there will be little progress on thrifting
for at least the next two years. A modest shift is
continuing toward substitution of platinum in
favor of palladium for diesel vehicles and to a
lesser degree gasoline vehicles. Although we do
not look for advances in thrifting to alter

47
 Commodities
Global
10 May 2011
underlying supply/demand balances
noticeably, substitution may reduce platinum
demand at the margin.
Gains in thrifting and substitution have also been
offset by increasingly stringent emissions
legislation. We discussed the positive impact on
platinum consumption worldwide in previous
editions of our Precious Metals Outlook.
Automakers continues to work toward the goals of
US legislation in 2010, which set emission and
mileage standards that would translate to a
combined fuel-economy average for new vehicles
of 35.5 miles per gallon by 2016. The rules are
aimed at cutting emissions of carbon dioxide and
other heat-trapping gases by about 30% from
2012-2016. Chinese emission standards are based
on European regulations. China continues to seek
to impose emissions standards more rigorously.
Large metropolitan areas in China, including
Beijing and Shanghai, have adopted more
stringent regulations on an accelerated schedule,
ahead of the rest of the country. Beijing and
Shanghai plan to introduce strict standards from
2012. The more-stringent carbon-dioxide
emissions regulation globally requires greater
platinum and palladium loadings.
Industrial production: Still going
strong
The rebound in global industrial production
noticeably increased demand for platinum in the
glass, electrical, and chemical sectors. Consistent
with HSBC macroeconomic forecasts of
expanding global industrial activity, we forecast
increases in demand for platinum in a range of
manufacturing and industrial processes in 2011.
According to HSBC macroeconomics, global
industrial output could increase 6.4% this year
after rising 9.8% in 2010. This output in
developed economies is forecast to increase 4.1%
this year and in emerging markets to rise 9.0%.
Based on HSBC’s forecasts of industrial
48
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production and growth in key platinum-intensive
industries, we look for a continued rebound in all
major platinum-consuming segments for the rest
of this year. We forecast that industrial demand
for platinum will total 1.925moz for 2011, an
increase of 205,000oz from 2010 and a
c155,000oz increase from our previous forecast of
1.77moz for combined industrial demand.
Notable increases in industrial consumption of
platinum include that by the chemical industry,
which rose to 450,000oz in 2010 from 290,000oz
in 2009. This was based on increased demand for
chemicals in a wide range of applications, mostly
in North America and the emerging world.
Johnson Matthey estimates that electronic demand
have increased to 225,000oz from 190,000oz due
to a pick up in demand for hard discs, computers,
and other electronic devices. A strong recovery in
glass manufacturing was recorded for 2010 to
365,000oz from almost negligible levels in 2009,
after demand was boosted by the shift in LDC
glass production from the US and Western Europe
to China and Japan. Platinum purchases for
petroleum refining in 2010 dropped to 175,000oz
from 210,000oz in 2009, as little new refining
capacity was built in 2010.
With many of the world’s platinum-consuming
industries now located in the emerging world,
global industrial consumption of platinum is
likely to be influenced more by industrial output
in emerging-markets nations than in the
developed world. HSBC economic research
predicts emerging-market industrial growth will
be more than twice that of the developed world
this year.
This is especially the case with glass
manufacturing. In recent years, the bulk of the
world’s glass manufacturing has shifted to the Far
East. A continued rebound in consumer
electronics and glass demand worldwide would
continue to boost platinum demand well into
 Commodities
Global
10 May 2011
2011. Other platinum-intensive industries such as
chemicals should also continue to expand.
Although demand for platinum for industrial
applications should grow this year, we do not
expect that the sharp increase in 2010 will be
repeated. This is mostly because in addition to
meeting immediate demand, many industrial users
took advantage of the recovery in 2010 to boost
stock and inventory levels. This should lessen the
need to make new purchases this year.
Jewelry: A Chinese puzzle
We forecast net platinum jewelry demand will
moderate slightly to 1.6moz this year, a decline of
c85,000oz from 2010. A high price environment
and ample inventories and merchant stocks appear
likely to reduce jewelry demand. High prices also
are likely to encourage greater recycling.
Counterbalancing this is continued income growth
in China and the success of marketing efforts in
China and North America in promoting
platinum jewelry.
China accounts for the bulk of world demand for
platinum jewelry. Following strong increases in
Chinese consumption of platinum jewelry in
2009, demand slumped in 2010 in response to
higher prices. Chinese demand is likely to soften
further this year as high prices curb consumer
retail demand for platinum jewelry. High prices
also may stimulate increased recycling of jewelry
items in and outside China. The disaster in Japan
is likely to depress all forms of luxury goods
purchases in that country. Heavy imports of
platinum earlier this year may have left
merchants and manufacturers well-stocked for the
rest of 2011.
The recovery in global auto demand and fall in
jewelry consumption allowed the auto industry to
reclaim its position as the world’s largest demand
source for platinum. Jewelry, meanwhile, has
moved into third place behind the No. 2 category
abc
of aggregate industrial demand, according to our
supply/demand model. We anticipate that the
automotive industry will remain the largest
market for platinum, followed by industrial
demand and jewelry remaining in third place, for
the foreseeable future.
However, the jewelry market performs a vital
function as a balancing agent in the platinum
market. Unlike auto and most industrial
consumption, demand for platinum jewelry is
highly price-elastic. Platinum jewelry products
compete with a range of competitive alternatives,
including gold and other luxury goods. Platinum
jewelry demand typically declines when prices are
high, thus freeing up product for the autocatalyst
and industrial segments. Conversely, when prices
are low, jewelry demand tends to rise, thus
absorbing greater supply. The collapse in prices
below USD800/oz in late 2008 triggered a swift
consumer response, and platinum jewelry demand
rose notably. Conversely, the drop in jewelry
demand in 2010 reflected consumer reaction to
the steep rise in prices.
This degree of price elasticity does not exist
anywhere else in the platinum market. Without
this demand response from the jewelry market,
price movements during periods of
significant changes in industrial demand would be
likely to prompt much more severe price
responses, in our view.
Platinum jewelry demand is heavily dependent on
Chinese consumption. China alone accounted for
c1.2moz, or c70%, of total global demand in
2010. Meanwhile, net jewelry consumption in
Japan accounted for just 2% of world demand, in
part because of a jump in recycling levels.
In keeping with platinum’s sensitivity to price
changes, we believe that Chinese jewelry demand
began to ease notably when the market traded
back above USD1,500/oz in the summer of 2010.
49
 Commodities
Global abc
10 May 2011

This coincided with a drop in Chinese platinum ETFs: A continued US success

imports for most of 2H 2010. According to Investor demand will play a crucial role in
official trade data, Chinese import demand for determining platinum prices. The US PGM ETFs,
platinum rebounded from December 2010 through launched in January 2010, have been highly
March 2011. See the chart at the bottom of this successful and absorbed considerable amounts of
page on Chinese platinum imports. Recent metal. ETF demand, however, may be slowing
imports appear to be well in excess of domestic from the very strong levels of 1H 2010. Platinum
auto and industrial demand. This implies some investment demand also has benefited from the
pickup in jewelry demand. Demand for platinum rally in gold and is consistent with investor
jewelry may also have an investment component, demand for hard assets, rising inflation fears,
in keeping with the increase in demand for escalating commodity prices, and government
hard assets. deficit spending across the world. As long as
Chinese consumer demand for many luxury items, investors remain sensitive to highly
including platinum jewelry, may slow in the face of accommodative monetary policies and deficit
growing inflationary pressures, notably food and spending, we believe that investor demand for
fuel price rises, which account for a large platinum will remain strong. If investor demand
percentage of consumer incomes. The impact of remains at current levels, the market will stay in
higher platinum prices and inflation increases may deficit, according to our supply/demand model.
be partly offset by income gains and a stronger A feature of the platinum market is investor
CNY. Platinum also is the favored precious metal of demand, the locus of which is the ETFs. This
the growing upper middle class, a group with more increase in demand is so strong as to alter
discretionary income than most Chinese. significantly the underlying market
Platinum continues to gain popularity in the supply/demand balances. For 2010, the combined
market for engagement and wedding rings. It ETF holdings of the four major ETFs increased by
remains the most desirable wedding ring in Japan a sharp 555,000moz to 1.126moz. For calendar
and, more important, in the Chinese market, 2010, platinum ETF holdings of London-based
where official data list more than 9m ETF Securities dropped by 28,000oz to 384,000oz
weddings per year. from 412,000oz at the beginning of the year.
Holdings of the ZKB ETF fell by 84,000oz to
China: Platinum imports jump
249,000oz from 333,000oz at the beginning of the
12,000 Monthly China Platinum Imports year. The UK’s ETF Securities launched a US-
10,000
registered platinum and palladium trust in the US,
Imports (Kg)

8,000 which became active in January this year. To date,

6,000 it has been highly successful. US-listed platinum
4,000 ETF holdings totaled 445,000oz for 2010,
2,000 although the bulk of the gains came in the first
0 few months after the launch. Julius Baer launched
May-07

Nov-09
Oct-07

Mar-08

Jan-09

Jun-09

Apr-10

Sep-10

Feb-11
Aug-08

an ETF in March, which to date has a total of

Rolling 12 month average 48,000oz.
Source: Official trade data

50
 Commodities
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10 May 2011

Platinum: Supply/demand balance (000oz)

2003 2004 2005 2006 2007 2008 2009 2010e 2011f
South Africa 4,630 5,010 5,115 5,295 5,035 4,515 4,530 4,585 4.750
Russian production 880 880 890 920 910 805 785 810 820
Russian stock draw 170 -30 0 0 0 0 0 0 0
Russian sales 1,050 850 890 920 910 805 785 810 820
North America 295 385 365 345 325 325 260 210 270
Others 225 250 270 270 290 295 345 405 440
DLA 0 17 13 13 13 0 0 0 0
Total supply 6,200 6,512 6,640 6,830 6,600 5,940 5,920 6,010 6,280

Autocatalyst gross 3,270 3,490 3,795 3,905 4,145 3,655 2,230 2,985 3.110
Recovery -645 -690 -770 -860 -905 -1,130 -830 -1,095 -950
Net autocatalyst 2,625 2,800 3,025 3,045 3,240 2,525 1,400 1,890 2,160
Chemical 320 325 325 395 410 400 295 450 470
Electrical 260 300 360 360 320 225 180 225 390
Glass 210 290 360 405 390 315 10 365 335
Jewelry 2,510 2,160 1,196 1,640 1,460 1,365 2,445 1,685 1,600
Petroleum 120 150 170 180 210 240 205 175 200
Investment 150 45 15 -40 0 450 300 200 225
ETF 0 0 0 0 195 103 360 555 400
Other 470 470 475 495 475 535 440 505 530
Total demand 6.530 6,540 6,695 6,485 6,680 6,160 5,635 6,050 6,310

Market balance -361 -89 -55 355 -80 -220 280 -40 -30

Inventory build by auto cos. 150 -330 -0 -0 0 0 0 0 0

Real market balance -327 -275 -89 -55 355 -120 285 -40 -30

Platinum price (USD/oz) 529 540 846 846 897 1,306 1,565 1,210 1,850
Source: HSBC estimates, Johnson Matthey

This year so far, combined ETF demand is up We are raising our 2011 forecast of ETF investor
145,000oz to 1.271moz. Combined platinum ETF demand for platinum by 80,000oz to 400,000oz. We
holdings totaled more than 1.27moz as of end- also are raising our forecast of other non-ETF
April. This was equivalent to more than the investments, which include small bars and coins, to
annual output of Russia and Zimbabwe combined. 225,000oz from 125,000oz, based on strong investor
Demand for platinum is driven by the same demand for hard assets including platinum.
factors that are propelling investor interest in hard
assets in general, namely, concerns about
potential inflation, the USD, government deficit
spending, loose monetary policies, and
geopolitical tensions. These factors are likely to
support ETF demand for the rest of this year.

High prices may begin to deter retail demand for

the ETFs, but we expect institutional demand to
remain steady. High prices also could encourage
some investor liquidation of physical platinum by
retail holders, which could reduce non-ETF
platinum investment.

51
 Commodities
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10 May 2011

Palladium
 After many years of substantial supply/demand surpluses, the
palladium market is swinging into a structural deficit; this is likely
to have profound bullish consequences for price
 Dwindling Russian stock concerns, recoveries in global auto and
industrial output, and investor demand for hard assets should
offset higher mine output and weaker Chinese jewelry demand
 We are raising our forecasts of palladium prices and introducing a
forecast for 2013

Increasing our palladium price a pronounced psychological impact on the market,

forecasts which would drive prices higher.

We are raising our forecasts of average palladium
prices for:
 2011 to USD825/oz from USD750/oz.
 2012 to USD750/oz from USD650/oz.
 The long term (five years) to USD700/oz
from USD600/oz.
For 2013, we are introducing an average price
forecast of USD725/oz.
Already high but may go
higher
After many years of heavy supply/demand
surpluses, the palladium market has shifted to a
deficit. Based on our supply/demand model, we
believe that the market will be in deficit this year
by c310,000oz. Although this would be smaller
than the 2010 deficit, which we estimate at
455,000oz, we believe that continuation of a
deficit after so many years of surplus would have
Our expectation of a deficit is based on continued
investment demand in palladium exchange-traded
funds (ETFs). We anticipate investor demand for
hard assets and the need for an inflation and safe-
haven hedge to keep ETF demand firm, although
we expect the pace of investor off-take to
moderate going forward. That said, should ETF
investors turn net sellers and liquidate portions of
their holdings, the market could move into a more
substantial surplus, with a commensurate
impact on price.
Based on forecasts by HSBC economists and
equity research analysts of continued industrial
expansion and increases in global auto production,
we believe that industrial and automotive demand
will absorb considerable amounts of palladium
this year. Electronics demand for palladium
should be especially robust, we anticipate but
demand for auto production should moderate this
year from 2010 levels.

52
 Commodities
Global
10 May 2011
Despite an array of challenges, we expect the
palladium mine supply to grow this year, with a
notable recovery in North American output.
Power and accident-related disruptions in mining
have the potential to drive prices higher. The
likelihood that Russian palladium stocks are
dwindling could help support prices. We forecast
declining Russian palladium sales for this year.
Just as important, we believe that the widely held
perception that Russian palladium stocks are
inevitably falling is itself price-supportive.
Start and stop
Palladium prices reached multiyear highs of
USD827/oz on 28 February before easing back to
USD684/oz by mid-March. Prices have
subsequently rallied, hitting USD770/oz as of the
end of April. Palladium prices are almost five
times higher than their multiyear low of
USD157/oz, plumbed at the height of the financial
crisis on 16 October 2008. Prices moved steadily
higher throughout 2010, but have become more
volatile this year.
We believe that the disaster in Japan in the wake
of the earthquake and tsunami and the temporary
closure of Japanese auto plants provided the
catalyst for the palladium price decline in March.
Since the March sell-off, palladium has made a
less convincing recovery than its sister metal,
platinum, which also fell sharply in conjunction
with palladium. After recovering to USD800/oz
by mid-April, prices slumped briefly in early May
to USD700/oz in line with weakness in other
precocious metals.
Our supply/demand model forecasts a deficit of
310,000oz this year, representing a narrowing
from a 445,000oz deficit estimate for 2010. Still,
we believe that fundamentals remain compelling.
Based on HSBC economics forecasts of further
expansion in industrial production next year, we
anticipate continued growth in palladium off-take
in 2011. Strong industrial demand and continuing
abc
growth in auto production will boost physical
demand for palladium. Although we expect the
growth in palladium ETF demand in 2011 to slow
from last year’s strong levels, we still expect it to
be positive, based investor appetite for hard assets
stemming from fears about inflation and
fiscal profligacy.
Meanwhile, the scope for near-term increases in
production in Russia, South Africa, and
Zimbabwe is moderate. We anticipate a
substantial recovery in North American
production from depressed 2010 levels.
Palladium prices are high despite a decline in net
long speculative positions on the Comex. After
reaching a 2009 low of 515,400oz in early March,
net long speculative positions increased rapidly,
surpassing the record high of 1.36moz reached
during the week of 19 February 2008. Long
positions continued to grow, reaching an all-time
high of 1.975moz in early November last year.
Long positions subsequently fell to 1.656moz by
the beginning of this year. The decline accelerated
during the peak of the Japanese disaster, hitting a
low of 1.179moz by late March. As of early May,
net long positions stood at 1.346moz.
Supply trends
The total palladium supply rose slightly in 2010 to
7.14moz from 7.1moz in 2009, according to
Johnson Matthey. For this year, we forecast a
Palladium plummets and recovers
1,000
800
600
400
200
0
Apr-01
Apr-02
Apr-03
Apr-04
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apr-10
Apr-11
Palladium 100 dMA 200 dMA
Source: Bloomberg
53
 Commodities
Global
10 May 2011
slight decrease of 25,000oz in the total palladium
supply to 7.115moz. Despite a host of obstacles
facing producers, we believe that mine production
is likely to grow 450,000oz to 6.615moz in 2011.
We anticipate a sharp decline in Russian stockpile
sales to 500,000oz this year from c980,000oz
in 2010.
Russian stockpiles: Nyet
The Russian palladium supply has exceeded
domestic production by a wide margin for many
years. The shortfall has been made up by sales
from existing above-ground stocks. The level of
Russian palladium stockpiles is therefore a source
of lively debate in the PGM market. All palladium
stocks in Russia are held by Gokhran, the State
Precious Metals and Gemstones Repository under
the Ministry of Finance. Data on the size of the
stockpile, as well as the timing and quantity of
sales, are designated as state secrets.
Consequently, there is no reliable data on either
absolute stock levels or the government’s sales
intentions. The only thing that we can be
reasonably sure of is that for many years, Russia
has exported considerably more palladium than it
has produced. Thus, we infer that its stocks must
be declining. Much of the palladium price rally of
2010 was predicated on the likelihood that
Russian stocks were nearing exhaustion.
In the past few years, Russian stockpile sales have
been relatively steady, averaging a little less than
1moz a year. In previous years, sales showed
some sensitivity to prices, increasing marginally
when prices were high and edging down when
prices were low.
On 17 November 2010, the Dow Jones News
Service reported that an official at Gokhran said
the Russian state’s palladium stock was
“practically nil,” and that Gokhran was unlikely to
continue to sell much more palladium on the
world market. The finance ministry wanted to sell
palladium to raise liquidity, which in turn could
54
abc
be used to repay the country’s debts or to increase
its gold and foreign currency reserves, according
to the official.
Other market participants have also expressed
concerns about Russian stockpiles. In September
2010, Anton Berlin, marketing director of Norilsk
Nickel, said there might not be enough stockpiles
of palladium held by the Russian government to
pursue sales throughout 2011, though it was
impossible to know exactly how much palladium
is left in government stocks. These comments
reaffirmed his statements stretching back to 2008,
when he said that Russian palladium stocks would
be exhausted in one to five years. The five-year
time frame for stock depletion was first made
nearly three years ago, leaving at most room for
possibly two more years more of exports at the
rate of c1moz a year.
If additional Russian exports and sales of
palladium are not forthcoming, this may be an
indication that the stockpile is indeed dwindling,
compelling the authorities to husband metal. In
the event of a decrease in Russian stockpile
exports and sales and continuing growth in
automotive and industrial demand, the only
immediately available stocks of any magnitude
may be from the ETFs. Rising prices, however,
may encourage investors to add to the ETFs,
rather than liquidate, thus intensifying a rally.
The perception that Russian palladium stocks are
contracting may be more important than the actual
size of the stockpile. Based on our conversations
with market participants, we believe that the
perception that stocks are dwindling and may
soon be exhausted is widely held and is a key
element of the current rally. Even if stockpile
sales and exports increase, the belief that stocks
are inevitably shrinking and may soon be spent
will continue to support prices, in our view.
 Commodities
Global
10 May 2011
Heavy sales of palladium stocks by Russia have
been a feature of the market for many years.
Without Russian stockpile sales, the palladium
market would have run deficits in 2008 and 2009
instead of surpluses. For last year and this year,
the absence of Russian stockpile sales would push
the market deeper into deficit, according to our
supply/demand model. Based on the assumption
that Russian stocks are falling and that the
authorities may wish to husband existing stocks,
we estimate Russian stock sales will be
c500,000oz this year. This represents a sales
decline of almost 50% from the three
previous years.
According to Johnson Matthey, Russian platinum
production increased to 2.73moz in 2010 from
2.675moz in 2009. We forecasting a 20,000oz
increase to 2.75moz for this year. We base this on
Norilsk statements, which estimate that 2011
domestic output of palladium will total between
2.700-2.715moz. In 2010, Norilsk’s output of
palladium in Russia reached c2.7moz and the
group’s international operations produced
c150,000oz of palladium. Better-than-anticipated
grades in nickel deposits, from which palladium is
derived, helped sustain Norilsk production. In
addition, we expect output from alluvial producers
to add to Russian output.
South Africa: Catching up
South Africa is the world’s second-largest
palladium producer, just behind Russia, according
to our supply/demand model. In the longer term,
South Africa appears likely to overtake Russia.
Unlike Russia, South Africa holds vast palladium
reserves, in the same deposits as its equally vast
platinum reserves. All South African palladium
output is derived as a byproduct of platinum
production. High platinum prices have spurred
efforts by producers to increase platinum
production, which in turn yields greater palladium
output. With palladium prices still above
abc
South Africa and Russia: Mine production (000oz)
3.5
3
2.5
2
1.5
1
0.5
0
2003 2005 2007 2009 2011f
South Africa Russia
Source: Johnson Matthey, HSBC,
USD700/oz, producers have sufficient reason to
increase palladium output wherever possible.
South African palladium producers face the same
obstacles and challenges that limit platinum
production, as discussed in the platinum section of
this report. These include but are not limited to
rising costs, safety-related stoppages, inadequate
infrastructure, unreliable power supply, often
difficult labor relations, problems associated with
a strong ZAR, and shortages of trained personnel
and mining equipment. Producers also have
complained that government legislation has
become more intrusive and regulation more
burdensome. Efforts to improve safety conditions
may constrain output, as producers, labor unions,
and governments work to limit the potential for
mine accidents. The chart above shows South
African and Russian production.
South Africa is home to the bulk of the world’s
palladium reserves, as well as platinum reserves,
as we discussed in the platinum section of this
report. We remain positive about the long-term
potential for increased South African production
of palladium. In their search for platinum,
producers will derive more palladium, as platinum
mined in the huge Bushveld complex is
palladium-rich. Despite ample reserves and high
prices of palladium, it still will take years to lay
55
 Commodities
Global
10 May 2011
the necessary infrastructure to derive significantly
more palladium, according to the South African
Chamber of Mines.
Despite these impediments, we forecast an
increase of c150,000oz in South African
palladium production to 2.635moz in 2011 from
2.485moz in 2010. The chart on the previous page
showing South African and Russian mine output
is based in part on the latest statements from the
major producers, including Anglo Platinum,
Impala Platinum, Lonmin, Aquarius Platinum,
and Northam.
Zimbabwe: A lot there, too
Zimbabwe has substantial palladium reserves
along with platinum, located mostly in the Great
Dyke region. The potential for palladium
production is significant. According to a report
issued in April by the consultants Frost &
Sullivan, Zimbabwe’s mining output, which
includes palladium, could grow 44% this year,
about the same rate of expansion as last year.
Percentage increases may be deceptive, however,
as Zimbabwe production is starting from a
low base rate.
Zimbabwe has a distinct advantage in that its
PGM and other mineral occurrences are shallower
than those in South Africa and in most other
countries. This allows for opencast mining, which
is significantly less expensive than deep-level
mining. However, many of the other drawbacks
that constrain palladium and other precious-metal
production in South Africa also afflict Zimbabwe.
These include a lack of infrastructure, specifically
transport, power, and access to fresh water. The
shortage of skilled geologists, mining engineers,
and trained manpower in Zimbabwe is less acute
than in neighboring South Africa but is
nonetheless a constraint on production.
56
abc
To capitalize fully on its potential, Zimbabwe’s
mining industry needs foreign investment of
USD5bn, according to the Chamber of Mines.
However, this might be hard to achieve. A major
deterrent to investment in the Zimbabwean
mining industry has been indigenization
legislation. Indigenization aims to put a 51%
share of any investment in the country in the
hands of Zimbabwean nationals. The laws require
that foreign-owned mining companies present
plans on how they will transfer ownership of
stock to Zimbabwean nationals by 10 May. The
deadline for the stock sales is 25 September. This
deadline has been pushed back several times, due
to difficulties in implementing the legislation.
Prime Minister Robert Mugabe in April stated his
intention to see the sales through as soon as
possible. Concerns about indigenization could
stifle foreign investment and jeopardize future
palladium production.
Political attitudes on the mines may be hardening.
In his 2011 budget speech, Finance Minister
Tendai Biti said that the government had received
only USD20.7m from royalties from the sale of
precious metals in the nine months ended
September 2010, while producers had earned
USD593.8m from precious metals sales. We
estimate that mine production – excluding South
Africa, Russia, and North America – will total
c500,000oz in 2011, up from 385,000oz in 2010,
and that much of this increase will come
from Zimbabwe.
On the positive side, the Zimbabwean government
has supported the mining industry by easing some
of the more-restrictive financial regulations.
Output has been boosted by government
relaxation of capital control laws, allowing mining
companies greater access to multiple foreign
currencies. This has enabled companies to
purchase much-needed machinery, equipment,
and consumables.
 Commodities
Global
10 May 2011
Palladium derived from auto recycling
1.4
1.2
1 sold for scrap offset by slightly lower palladium
0.8
0.6
0.4
0.2
0 handed in for scrap from Asia to grow significantly
2003 2004 2005 2006 2007 2008 2009 2010 2011f
Source: Johnson Matthey, HSBC
We expect North American palladium production
to bounce back up to 730,000oz in 2011 from
560,000oz in 2010, when levels were depressed
by labor strikes and other production problems.
Recycling trends
The supply of secondary metal coming from spent
autocatalysts has increased sharply in recent years
from less than 50,000oz in 2002 to more than
1.32moz in 2010, Johnson Matthey has estimated.
The only exception to this steady trend higher was
2009, when the global economic crisis resulted in
a near-collapse in new auto demand and led
consumers to hold on to older vehicles that might
otherwise have been traded in for scrap. In 2009,
auto scrap recycling fell to 965,000oz from
1.14moz the previous year.
We forecast a very slight 10,000oz increase in
auto scrap recycling this year to 1.33moz. The
continued recovery in auto demand implies
greater levels of scrap supply. This will be offset
by the types of vehicles traded in, which have
typically lower palladium loadings than those
models that owners turned in under the “cash for
clunkers” program in the US and similar programs
in other countries.
Higher prices of platinum and palladium have also
increased throughput of stocks of spent
autocatalysts. Based on our conversations with
abc
recyclers in the OECD world, we believe that scrap
supplies are running near last year’s levels, with the
impact of a slightly greater volume of autos being
loadings. An increase in the number of vehicles
from the emerging world, which have heavier
palladium loadings, will also support recycled
palladium supplies. We expect the volume of cars
in the next few years, given the strong increase in
demand for new autos, which began in earnest in
the mid-2000’s. The nearby chart shows palladium
derived from auto recycling.
Demand trends: Shifting gears
Demand for palladium, like its sister metal
platinum, has been strongly affected by the
recovery in global automobile sales and
production. According to Johnson Matthey, global
automotive demand for palladium in 2009
slumped to just 4.05moz, a decline of more than
400,000oz from the previous year. The recovery
in automotive production in 2010 pushed
palladium demand for vehicles to 5.15moz,
exceeding 5moz for the first time.
Based on HSBC equity research analysts’
forecasts of auto sales, which we discussed in the
platinum section of this report, we expect gross
autocatalyst demand for 2011 to increase by
205,000oz to 5.355moz. The slowdown in the rate
of growth of auto production this year, compared
to 2010, explains our forecast of a moderate
increase, compared with last year.
Palladium off-take for the automotive industry
will continue to benefit from growing demand for
autos to the emerging world. In the faster-growing
markets of China and India, consumers favor
gasoline-driven vehicles. Gasoline-fueled vehicles
rely primarily on palladium-heavy autocatalysts
and use proportionately more palladium than
diesel vehicles.
57
 Commodities
Global
10 May 2011
Palladium loadings also are benefiting from
increasingly stringent fuel standards around the
world, which often require heavier PGM loadings.
We discussed this in more detail in the platinum
section of this report and in previous editions of
our Precious Metals Outlook. We expect little
near-term change in palladium loadings due to
substitution or thrifting.
The worldwide recovery in industrial production
in 2010 led a surge in palladium demand for
industrial and manufacturing applications. Better-
than-expected demand for glass and high-end
electronic goods, such as liquid crystal displays
(LCDs), lifted palladium consumption. Demand
also was strong for chemical and petroleum
applications. According to Johnson Matthey,
industrial demand for palladium in 2010 rose to
1.53moz from 1.388moz in 2009. We believe that
combined industrial demand for palladium could
rise to 1.8moz this year, based on the HSBC
macroeconomic forecast for global industrial
production growth of 6.4% – with growth of 4.1%
in the OCED nations and 9.0% in the emerging
world – and on our conversations with executives
in the electronics industry, the largest single non-
automotive industrial user of palladium. In
dentistry, we expect palladium demand to fall to
600,000oz in 2011 from 620,000oz in 2010, as the
metal is gradually replaced by other materials.
Jewelry: The East is moderating
The bulk of the world’s palladium jewelry is
consumed in China. Demand is noticeably
volatile. As recently as 2002, total global demand
for palladium was less than 250,000oz. Demand
rose to a high of 1.43moz in 2005. Consumption
subsequently eased to 545,000oz in 2009, as
estimated by Johnson Matthey. We account for
this decline partly from the rise in popularity of
platinum jewelry and its price-competitiveness
with palladium in 2008 and 2009, when platinum
prices almost collapsed in the wake of the global
58
abc
downturn in the auto market. We forecast a
moderate recovery in palladium purchases for the
jewelry sector to 600,000oz this year from
630,000oz in 2010.
Palladium jewelry demand remains modest but is
growing, based on our conversations with
manufacturers and merchants. The more vigorous
rally in palladium prices has dimmed its price-
competitiveness with platinum and gold, despite
price increases in all the precious metals. Although
demand for palladium imports into China has been
strong so far this year, we believe this was mostly
for the industrial and auto segments. Also, Chinese
merchants and manufacturers may have been
overstocked with palladium from heavy imports in
the past few years and therefore reluctant to
increase purchases.
Our forecasts also are based in part on the lack of
major advertising campaigns in China and less
promotion of palladium jewelry in Western
markets, compared to the mid-2000s. Economic
uncertainty and high unemployment in the West
also are likely to limit palladium jewelry demand.
ETFs: Eerily quiet for now
Palladium ETFs have proven to be a popular
investment vehicle. The combined holdings of
ETF Securities and the ZKB palladium ETFs
racked up a huge 1.06moz in off-take in 2010.
The new US-listed ETF Securities’ PGM ETF,
introduced in January 2010, has been very
successful, accounting for 1.125moz last year. A
new ETF from Julius Baer introduced in
Switzerland in March increased off-take to
48,000oz last year. The other two palladium
ETFs, the ZKB and the UK ETF Securities,
declined by 58,000oz and 96,000oz, respectively,
to 447,000oz and 533,000oz.
The success of these ETFs has clearly tightened
underlying palladium supply/demand balances. The
large off-take from the ETFs helped push the
 Commodities
Global abc
10 May 2011

Palladium: Supply/demand balance (000oz)

2003 2004 2005 2006 2007 2008 2009 2010e 2011f
South Africa 2,320 2,480 2,605 2,775 2,765 2,430 2,370 2,485 2.635
Russian production 2,700 2,971 3,135 3,220 3,050 2,700 2,675 2.730 2.750
Russian stock draw 250 1,150 1,485 700 1,490 960 960 980 500
Russian exports 2,950 4,800 4,620 3,920 4,540 3,660 3,635 3,710 3,250
North America 935 1.035 910 985 990 910 755 560 730
Others 245 265 270 270 285 310 340 385 500
DLA 141 32 0 0 0 0 0 0 0
Total supply 6.591 8,612 8,405 7,950 8,580 7,310 7.100 7,140 7,115

Autocatalyst: gross 3,450 3,790 3,865 4,015 4,545 4,465 4,050 5.150 5,355
Recovery -410 -530 -625 -805 -1,015 -1,140 -965 -1,320 -1,330
net 3,040 3,260 3,240 3,210 3,530 3,325 3,085 3,830 4,025
Electrical 900 920 970 1,205 1,235 1,025 875 965 1,200
Chemical 265 310 415 440 375 350 325 385 400
Dental 825 850 815 620 630 625 615 630 600
Jewelry 260 930 1,430 1,005 715 855 745 545 600
Other 140 290 485 135 95 120 188 180 200
ETF 250 375 507 1,060 400
Total demand 5,430 6,560 7,355 6,615 6.830 6,675 6,340 7,595 7,425

Movements in stocks 1,161 2,052 1,050 1,335 1,750 635 760 -455 -310

Inventory build by auto cos. -400 -100 0 0 0 0 0 0 0

Real movement in stocks 1,561 1,952 1,050 1,335 1,750 635 760 -455 -310

Palladium price (USD/oz) 210 230 201 320 355 347 353 525 825
Source: HSBC, Johnson Matthey

market into deficit last year and we believe it will

do so again this year. Palladium ETF demand has
been flat so far this year far. We expect ETF
demand to pick up later in the year, based on our
expectation of continuing investor appetite for hard
assets, strength in other precious metals, and
concern that Russian stockpiles may be dwindling.
We do not expect to see any significant ETF
liquidation. We anticipate that the ETFs will
contribute 400,000oz to demand this year.

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Notes

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Notes

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Disclosure appendix
Analyst Certification
The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the
opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their
personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific
recommendation(s) or views contained in this research report: James Steel

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Additional disclosures
1 This report is dated as at 10 May 2011.
2 All market data included in this report are dated as at close 06 May 2011, unless otherwise indicated in the report.
3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its
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Global Currency Strategy Research Team

Global Technical Analysis
David Bloom Murray Gunn
Global Head of FX Research +44 20 7991 6797 murray,gunn@hsbcib.com
+44 20 7991 5969 david.bloom@hsbcib.com
Precious Metals
Asia
James Steel
Perry Kojodjojo +1 212 525 6515 james.steel@us.hsbc.com
+852 2996 6568 perrykojodjojo@hsbc.com.hk
Daniel Hui
+852 2822 4340 danielpyhui@hsbc.com.hk
Dominic Bunning
+852 2822 1672 dominic.bunning@hsbc.com
United Kingdom
Paul Mackel
+44 20 7991 5968 paul.mackel@hsbcib.com
Stacy Williams
+44 20 7991 5967 stacy.williams@hsbcgroup.com
Mark McDonald
+44 20 7991 5966 mark.mcdonald@hsbcib.com
Daniel Fenn
+44 20 7991 5003 dan.fenn@hsbcib.com
Murat Toprak
+44 20 7991 5415 murat.toprak@hsbcib.com
Mark Austin
Consultant

United States
Robert Lynch
+1 212 525 3159 robert.lynch@us.hsbc.com
Clyde Wardle
+1 212 525 3345 clyde.wardle@us.hsbc.com
Marjorie Hernandez
+1 212 525 4109 marjorie.hernandez@us.hsbc.com